Businesses prefer to keep money on hand for as long as possible, which is why they are often slow to pay their bills. Penalties and discounts improve your cash flow by cutting late payments and incentivizing faster payments.
Discounts encourage faster payments
Discounts are one of the best ways to encourage faster payments. Sometimes, it can even motivate customers who otherwise aren’t in a hurry to pay before the latest possible due date.
If you offer a discount, make sure you list it on the invoice, along with the number of days the customer has before it expires. (ex: 2/10, Net 30. That’s a two percent discount if the customer pays in 10 days. After that, they will have to pay full price when the invoice comes due in 30 days.)
Discounts have to be worked out carefully. Too small and no one will take advantage of them. Too large and they’ll wipe out your profit margins. The average is 2-4 percent, but if you don’t know what to offer, check out other companies in your industry. They’re your best guide.
Penalties discourage customers from paying late
Penalties are an easy way to encourage customers to send payments on time. But you can only charge penalties if they are in the original contract or work order. You also have to list them in the invoice, along with the deadline.
To determine the size of the penalty, start by working out your annual interest rate. Then divide by twelve to get your monthly rate. According to QuickBooks, most companies typically charge a 1-1.5 percent penalty per month.
No one likes to pay penalties, which is why they’re such a great motivator. However, in certain situations, it may be in your best interest to be generous and ignore penalties. Waiving penalties for long-time customers strengthens your relationships with them. They may even feel comfortable explaining the reasons behind their late payment, so you can review whether it’s worth granting an exception.
Keep in mind that while customers appreciate your generosity, it’s also important to establish clear parameters for waiving fees. For instance, though you may elect to waive a fee for an unforeseen circumstance, it’s important for your customer relationships ‒ as well as your budget ‒ to make clear that future invoices won’t be given the same leniency.