If when I purchase something I pay for it immediately why do companies/government/orgs after approving a transaction and/or receiving the work take 1-2months to pay for it?
EDIT: I am a new agency owner, so trying to figure out cash flow
EDIT 2: thank you guys so much for the detailed answers! Really helped me further narrow down the kinds of customers I do and don’t want to work with moving forward.
In: 2
From a construction pov, we are purchasing materials for the client. Net 60 allows us to bill the client so we can pay for the materials with funds from them. That way, we aren’t financing so much of their project.
A number of factors will one into play, but I will only provide one example.
Most of these companies may not get paid for selling the goods until the goods are installed, sold, or consumed. They setup agreements with suppliers to have some time to get their payments from customers and it is typically a mutually beneficial relationship.
Think of it like a store credit card, where you can make a purchase and pay later, but for business.
A couple reasons.
First, is typically those dollar amounts are significant: it’s not paying 100 dollars to the store or even 1,000 dollars to a painter.
It’s paying hundreds of thousands or millions of dollars. Companies/Governments/etc don’t just keep that money sitting around for the whole project ready for it to be done. They would rather be able to use that money for other things, and then once the project is finally actually done, since projects often get delayed, have a month or two to then bring the money together to pay for it.
Another thing is it gives them a chance to check your work and dispute you. If you did a job and they paid you right away, and then two months later they finally get around to looking at it and find something wrong, it’d be tough for them to get their money back. By legally withholding payment by the term of the contract, it gives them time to look over and check you. And then if they find something they typically then get to invoke another part of the contract about getting whatever the problem is fixed.
Essentially, taking that two months does nothing but help the company/government, and the workers/contractors will accept those terms when it comes to jobs that are hundreds of thousands to millions of dollars.
Anyone in business is eventually passing on those costs to their customer. It is better if they can delay payment until after they have been paid.
As several folks have said, if I buy paint for a job, I don’t get paid for the job until I finish it. I’ll buy paint from the store that works with me to take their $$ after I get $$ from my customer.
This is true of lawyers, and clerical workers too. They buy coffee, envelopes, printer paper, staples, etc – ultimately their customer pays for all of that.
It isn’t essential to offer 30/60/90 days – but it can make a huge difference for a small business, or one with cash flow issues, or one that is capital intensive.
I’ll pay slightly more for paint on 90 day terms, so that store has an edge over anyone else in attracting painters like me.
(I’m not actually a painter – just using that example).
Many companies are large enough that there are several (possibly even tens or hundreds of) people working there. Not everyone gets a company credit card, or access to the company bank account or to the company PayPal account, or whatever, because it would be a huge security risk to give everyone access to all the company’s money, and it would also be an incredibly pain to set up everyone as signatories with all the financial services.
So, access to the finances is usually restricted to just a few key people or to a single department, who then handle all the finances for the whole company. They would be the people paying your invoice when you bill that company for a service or goods that you provide to them.
But since you might be dealing with Ian in IT (who buys a computer or some online service from you), he is not the person who will actually pay you. You send Ian the invoice, and Ian has to pass it to Fred in finance, who then reconciles this with the budget and the accounts and all that jazz, and adds the invoice to the “please send payment” pile.
But since batch processing tends to be more efficient than switching tasks constantly (or even worse, attempting to multitask!), companies tend to pay all their bills at one time. This also means that they can work out what the total amount to pay is going to be, and move money between accounts if necessary (or arrange a cashflow loan) so that all those bills can indeed be paid. Then someone sits down and spends the day paying bills.
That can’t happen immediately when you send the invoice. In fact, many companies tend to send payments only once a month. Therefore, if you don’t give them a net-30 invoice (an invoice that is to be paid within 30 days), then they might not pay you on time and they will count as defaulting. You will then have to mark that they missed the payment, and chase them up – quite possibly only to be told that they pay invoices on the last day of the month, so they’ll get round to it then and not before.
Some companies (or non-company organisations, such as government agencies or city councils or suchlike) may need to pay so many bills that they do need to arrange for a cashflow loan to make sure that the right amount of money is in place to pay those bills at that specific moment when the payments are to be sent. Since a loan takes time to arrange, such an organisation might need to start arranging it the month before – so you might need to submit your invoice in January, so that they can arrange the loan over the course of February, so that the money is in place for the actual day of payment in March.
And now, if you didn’t give them a net-90 invoice (to be paid within 90 days, or three months), they will be defaulting, and you’ll have to chase them up, only to be told that payments come two or three months in arrears and to suck it up until it comes time for your invoice to be paid.
It can therefore be quite difficult for small businesses to deal with large organisations on these kinds of terms, because you probably need to receive the income now in order to meet the immediate obligations and costs for your business. That is, however, your problem, as harsh as that sounds. It might in fact be better to avoid doing any business dealings at all with organisations of this kind of size if you cannot afford to wait to receive payment until their finance department gets around to it.
Large companies find it quite easy to do business with other large companies, because they are all playing the same kind of game to the same kind of rules, and have the same kind of financial buffer or cashflow financing to keep themselves above water until the next round of payments come in. Small businesses can easily go bust waiting for large companies to send a payment.
Of course, not all companies work like this. Some companies are faster, more agile, or just generally better to do business with. They probably have more people with company cards who can send payment immediately, or otherwise they have a smoother, faster process for receiving an invoice and sending payment, so that they do not carry a liability on their balance sheet for accounting purposes.
Personally, as someone who runs a small business, I much prefer to deal with other small businesses! It makes my life much easier when other people are in the habit of paying bills relatively quickly. I also understand that when I do sell to a larger organisation, I am at the mercy of that organisation’s payment policies, and I’ll get the money when I get it. Therefore, I try to balance how much much I sell to bigger organisations compared with how much I sell to smaller business or directly to individuals.
Answer: these are lists of different ways of doing things. You are allowed to negotiate. If Net30 is bad for you, then negotiate payment a different way. The standard contracts are standard because they work for a lot of people, but a lot is not the same as everyone.
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