B2B

B2B Businesses Need a Customer Credit Model

The B2B credit model has hindered growth and sustainability in the small-to-medium business market. Here’s what the B2B credit model should look like.
Latest posts by Dan Drechsel (see all)

Since the 1920s, credit cards have enabled merchants and consumers to conduct critical business transactions that benefit both parties – merchants receive risk-free, real-time payment on sales, and consumers are allowed several weeks to complete payment on purchases. This form of business-to-consumer (B2C) credit has largely contributed to the formation and success of the world’s economy. Yet, this concept has never translated into a payment model for merchant-to-merchant (B2B) businesses – a segment of the market that represents billions upon billions of dollars.
Small and medium-sized businesses across the world extend trade credit to their customers on the premise that they will eventually get paid. Unfortunately, however, businesses often wait several weeks to receive payment and some invoices are not paid at all, leaving millions of dollars in what can be thought of as the black hole of trade credit.

The B2B credit model has hindered growth and sustainability in the SMB market, especially in times of financial crisis. Small business owners are calling in favors with family and friends and pouring their personal finances into businesses to keep them afloat in the face of a frozen lending market and late payments. Businesses should correct this system and take a cue from the consumer credit model for best practices in customer credit before it’s too late.

Here is a breakdown of what aspects of the B2C model would work for the B2B market.

Accelerated Payment

In the B2B space, it generally takes a business 56 days to get paid by its customers. For a company selling $20,000/week, that’s eight weeks of sales outstanding, which equals $160,000 in untouchable assets. On top of that, businesses are constantly racking up invoices with their own vendors – meaning businesses are typically being drained on both ends of the books.

What would the difference be for a small business if it could have guaranteed access to 90% of its capital almost immediately rather than in 7-8 weeks?

There are several financing solutions on the market that provide lines of credit and alternative sources of funding for SMBs so that they can leverage the cash flow that they need in a reasonable period of time. Traditional options include applying for a bank loan (although these are hard to come by in unsteady economic times) or factoring your account receivables. Factoring provides immediate access to cash, but it can be very expensive (24-34%) and potentially damaging to a customer relationship.

An additional approach for B2B businesses is alternative financing from financial institutions and nontraditional funding providers. An exceedingly popular method of alternative financing is securing an accounts receivable line of credit from a financial institution in partnership with a monitoring firm. Credit monitoring firms enable banks to lend against accounts receivables at bank loan rates by managing a business’ A/R and transforming it into transparent, lendable collateral. Capitalizing on an open line of credit against your A/R is an incredibly efficient way to continue growth without taking on debt. This program is also available as a Small Business Administration loan known as CapLine.

With this kind of alternative financing, customers complete payment under the same terms they would if your business were extending a line of trade credit to them. Businesses can set payment incentives to accelerate the time it takes for invoices to get paid, but at the end of the day, nothing changes for customers. And, the only change for businesses is that they have almost immediate access to the capital that is owed to them.

Minimized Risk

Another benefit to the B2C credit model is the advantage merchants enjoy by relinquishing credit risk to credit card companies. Let’s face it: the days of customer responsibility are over. Business owners can no longer afford to keep an open tab for customers in good faith.

The B2B market needs a model that insures businesses will get paid for the sales they make. Trade credit insurance has provided sanctuary for small businesses in this regard so far, but the recent bankruptcy of CIT Group, Inc. supports the argument that B2B companies need a more sustainable model for protecting sales. As Victoria Knight of The Wall Street Journal states, “The troubles at CIT underscore the importance of developing back-up plans for borrowing.”

Outsourcing a business’ A/R function inherently protects businesses from unpaid invoices. Similar to a B2C company accepting a credit card for payment, outsourcing A/R puts the invoicing burden on the credit provider. By working with financial institutions, the credit management vendor borrows against the small business’ A/R, takes on the debt and provides you with the capital upfront. The credit management vendor is then responsible for collecting payment from customers and ultimately responsible for the sale.

Credit management companies also often have credit scoring models in place that allow them to keep tabs on a business’ customers. By scoring current and prospective customers before selling to them, businesses that outsource and borrow against their A/R typically have better insight into the credit standing of their customers. This allows businesses to make better determinations around which customers to sell openly to and which customers they should modify their payment standards for. For example, a business might ask customers in questionable financial standing to pay 50% of invoices upfront to avoid losing out on that investment all together.

Outsourced A/R Functionality

Lastly, B2B companies stand to benefit greatly by outsourcing the business functions around A/R in an effort to decrease overhead and streamline processes for receiving payment. Credit management companies typically have a defined set of best practices to automate a business’ accounts receivables and oftentimes a transparent platform they use to do so. In the same vein of B2C merchants putting the burden on credit card companies to process payments, SMBs can depend on credit management providers.

For SMBs that sell to other businesses, outsourcing their A/R function could be as seamless as outsourcing the payroll function. Through outsourcing A/R, sales are immediately uploaded to an automated system, the credit management provider processes those sales in real-time, businesses can then tap into a revolving line of credit for short-term payment and the credit management company takes it from there. No follow-up calls. No tracking down payments. No lending capital you don’t have.

Although the economic picture for 2010 looks positive, businesses still need to be creative in how they prepare for and finance growth. The old models either don’t exist or don’t work anymore. B2B companies can benefit just as much as B2C companies from a customer credit model that has been proven successful and offers a credible alternative to business as usual.

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