You have been asked to provide business advice to a firm that is in a highly competitive but mature industry environment. Despite their highly efficient operations and relatively tight cash position, they very much want to boost their sales. They believe the best way to accomplish this is to extend the required customer payment periods – and are ready to pursue this course of action.
For your review: assess and evaluate this plan and its implications for the firm.
The company’s greatest challenge if they proceed with extending the customer payment period would be unstable cash flows. Since the company has already established a highly efficient financial system coupled with a tight cash position, extending the payment period would mean that the company has to sustain the longer wait period for the cash inflows. This would eventually result in a cash strap situation and the company would suffer from insufficient liquidity to meet their operational costs.
Extended payment periods also increase the chance of bad debts occurring. Bad debts are receivables that the business is unable to recover and is thus forced to write them off. In such a situation, the company’s profits are lowered. Collection agencies may also be used to recover some of these debts but such services come at a fee that would ultimately impact the expected revenue.
In spite of the challenges cited, extended payment periods may result in repeat customers and a higher referral rate given the flexible payment terms. This may result in higher revenues and profits for the business.
Extending the payment period also helps the business in selling high value items. This is because the payments are split up and paid off over a longer period of time, making the product affordable to the customer.
Extending payment periods presents both advantages and disadvantages, however it is advisable to ensure payments are received as soon as possible mostly because of cash flow issues and bad debts. The company may proceed to extend the payment period but also offer discounts on early payments to discourage the need for the payment extension.