Controlling Purchase Costs – Getting Vendors to Extend Credit
It can be hard for new, small, unproven businesses to get credit terms from vendors. In fact, some vendors may insist on deposits or cash on delivery until they’re comfortable with your company. Even though your brand-new business won’t have a credit history, let alone a credit rating, there still are things you can do to help convince vendors to extend credit to your ﬂedgling company.
When a vendor offers you an early payment discount, do whatever you can to take advantage of it. Although 1 percent or 2 percent doesn’t seem like much at face value, it can add up. Every penny you save on your purchases translates into an extra penny of profit for your pocket.
From your company’s perspective, you want to ask for as much credit as possible for as long as possible. Learn what the industry norms are, and what’s standard in your local area before you start talking to vendors. If typical terms include a $5,000 credit line and a 60-day payment window, don’t ask for $1,000 line for thirty days; if you ask for less, you’ll probably get less.
Once you’ve gotten credit established with a vendor, make sure to pay promptly, especially in the beginning of your relationship. As your company develops a sterling credit reputation, you’ll be able to ask for even better terms: a higher credit line, a longer payment window, early payment discounts. On top of that, vendors are more likely to go the extra mile for customers who make timely payment. That can come in handy when you need something unusual, like a last-minute special order.
It helps if you think of your vendors as potential ﬁnanciers for your business. Every time they let you buy something now and pay for it thirty days from now, it’s as if they’ve given you a short-term interest-free loan, some- thing no smart entrepreneur would ever turn down.
Why You Want Vendor Credit
It’s important to understand why it’s crucial for your company’s success to get those vendors to let you buy now and pay later. Inventory and other major purchases are among the biggest cash drains your company faces, and postponing the inevitable payout improves your cash-ﬂow situation.
Here’s how the cycle works without vendor credit. On Monday, you get ten inventory items and pay $500 for them. That inventory hits your shelves on Tuesday. By the end of the week, you’ve sold four units for $100 each, and two of those sales were on account; that means your company has brought in only $200 cash so far, after putting out $500, which gives you a $300 cash-ﬂow deﬁcit. If you have vendor credit, you put out no money up front but still would get $200 back, for $200 of positive cash ﬂow. You would pay your vendor for the initial purchase after you started bringing in money because of it.
In a nutshell: Without credit from your vendors, you have to pay for your inventory before you sell even one item, creating a drain on your cash ﬂow. With vendor credit, you can pay for your inventory after you’ve begun selling it and collecting from customers, giving a positive boost to your cash situation.
How to Get Vendor Credit
Just as your company shouldn’t extend credit to a company it knows nothing about, so it is for your vendors. Until your company has a solid reputation and a sterling credit rating, it may take some creativity on your part to get vendors to let your company make purchases on account. Luckily, there are a few different tacks you can take to accomplish that. The ﬁrst step, though, always involves asking for credit.
All the vendor really wants is to feel assured that he’s going to get paid. It’s your job to provide that assurance. If you already have a set of ﬁnancial statements, no matter what time period they cover, you can show them to the vendor. Don’t worry if they show a small loss or a little negative cash ﬂow; as long as you have some cash in the bank, and ongoing revenues, you have a good weapon in your arsenal. If your ﬁnancial statements aren’t much to look at, or you don’t have any yet, show the vendor a pared-down version of your business plan. Include your sales forecasts and prospective ﬁnancial statements, but leave out any proprietary information.
Offer existing credit references, as well. If your company got a startup loan from the bank, let the vendor know. That tells him that the bank considers your company a worthwhile investment, and helps build his conﬁdence in your company.
Another thing to try when your company is new and unproven (meaning a credit risk for the vendor) is asking for lower-than-usual credit terms for a trial period. If the vendor normally offers a $5,000 credit line but is hesitant with you, ask for $1,000 line to start with. He has less to lose, and you have a chance to prove your company is reliable.