The means of payment for purchases scarcely seems like a topic generating interest for the small-business owners, customers, or policymakers. While payment is part of every business transaction, it would seem to offer few unanswered questions and no outstanding issues. But the means of payment employed for the goods and services sold is an important consideration to small-business owners for at least four reasons: first, the means of payment can attract customers or drive them away. If an alternative form of payment can attract customers and increase sales, the owner must consider introducing it. However, attractive payment options for the buyer are not always attractive payment options for the seller. Second, every payment form including cash has associated direct costs, but there are greater direct costs to a business with some forms of payment than with others. For example, credit cards require that a fee be paid to the credit card company; credit extensions, even in the form of invoicing, involve the time loss of money and added administrative costs for billing and collections. Third, cash flow can be affected. The longer money is retained by customers in lieu of payment the more difficult it becomes for small businessmen and women to pay their bills. When cash becomes short due to delinquent receivables, a business may be forced to borrow (at a cost) or forego discounts for early payment (at a cost). Finally, the form of payment allowed can result in direct losses as in the case of bad checks or bankruptcies. While a bankruptcy may result in partial payment, these losses for the most part are just money “out the window.” No business can afford them without compensating benefits. Getting paid, therefore, has immediate practical consequences for small-business owners. It also has public policy implications. The most obvious revolves around bankruptcy. But bad and bounced checks have been the subject of legislation as has the extension of consumer credit and late payment. Thus, this issue of the National Small Business Poll is devoted to the subject of a critical daily activity in the small business routine, Getting Paid.
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Problems Getting Paid
Slow or late payment is the most significant problem small-business owners encounter getting their money for the goods provided or services rendered. Nearly half (45%) identify it as such (Q#7). Another 16 percent label bounced or bad checks as theirs. Failure to get bills paid in full, e.g., disallowed charges (6%), bankruptcies (4%), and the cost of using credit cards (3%) are noted less frequently. Twenty-seven (27) percent either report that their primary problem is “other” or they did not offer a response. A small number of businesses, perhaps 2-3 percent appear to be strictly cash, i.e., immediate payment, no credit, no credit cards, no checks for all customers under all circumstances. True cash businesses obviously experience no payment problems. That leaves one-quarter who either do not have any payment problem or have one other than those listed.
The means of acceptable payment are often highly industry specific. What is common practice in one industry might not be tolerable in another. For example, members of the construction, manufacturing, and wholesale industries are substantially more concerned over late payment than are those in other industries. Retailers are substantially more concerned about bounced and bad checks than are other business owners. Such differences help explain the comparatively high percentage who say their most significant problem getting paid is “other.”
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The Means and Timing of Payment
The means (including the timing) of payment allowed obviously influences the types of problems encountered. Many small-business owners receive payment at the time of the sale. Twenty-six (26) percent report that they are paid exclusively at the time of the sale (Q#2A). Twenty-four (24) percent say that they are usually paid in that manner. About half, therefore, customarily receive their money immediately.
A corollary payment time occurs in industries such as construction where the “sale” is effectively made before the work begins. But aside for advances to purchase materials or progress payments, these owners are paid when their task is completed or the goods are delivered. Twenty-nine (29) percent say that they receive payment exclusively at that time and another 27 percent say that they usually do (Q#2E).
Immediate payment at the time of sale, job completion or delivery of goods are not mutually exclusive categories. In fact, 37 percent say that they are paid exclusively at one of these points in time. Since they are paid in immediate exchange for goods and/or services, over one in three small-businesses by definition cannot have a late or slow pay problem. Another 35 percent have a low likelihood of having a serious slow payment problem because their transactions usually have payment upon exchange. Only 11 percent never conduct business where payment is immediate.
A large group of small-business owners effectively provides trade credit to customers, though we call it “invoicing” or “billing.” These owners send (or leave) the customer a bill thereby financing the customer until payment is received. Twenty-seven (27) percent operate exclusively by invoicing (due upon receipt) and another 25 percent usually get paid via that system (Q#2C).
More recognizable credit arrangements or terms are extended exclusively by 8 percent of small-business owners and usually by another 12 percent (Q#2D). These credit-type arrangements range from formal installment plans to more informal “half this month and half next.” Just less than half (49%) say that they never get paid through credit type arrangements or special terms extended. Virtually the same number say that they extend credit even if not often.
An associated type of invoice payment comes through third parties. At times businesses such as auto body shops or health care providers will bill third-party payers such as insurance companies or government for work done on behalf of others, such as policy-holders or Medicaid recipients. Just 8 percent commonly involve third-parties (Q#2C). However, three of four small-businesses never bill a third-party payer and most others do only infrequently. As will be shown, distinguishing between invoices sent customers in general and third-party payer has consequences for small-business owners.
The data presented here and subsequently exhibited data suggest that many small businessmen and women do not think of invoicing as extending credit or making a credit-type arrangement. Rather, they often think of such a payment procedure as getting paid upon completion of a job or delivery of goods, particularly when payment is due upon receipt. This outlook unfortunately fails to capture the true cost of billing and the risks inherent in it.
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Just over half (53%) of all small-business owners extending credit typically employ terms of “net 30 days,” i.e., the bill is due in 30 days (Q#3a). The second most common set of terms is “due upon receipt,” i.e., the customer’s payment should be made upon receipt of the bill. Seventeen (17) percent expect payment on that condition. The remainder (30%) uses a variety of other terms. However, the data are clear that few employ credit arrangements that one typically associates with credit card companies or large retailers. For example, only six percent indicate that they use an installment payment system and virtually no one volunteered that they used a revolving-type charge plan. Several reasons explain the infrequency of these more complicated credit arrangements including inadequate cash, administrative costs and hassles, and compliance with legal requirements.
Invoiced customers pay on average in 29 days (Q#3d). That average indicates many invoiced customers do not pay on time. Further, 25 percent of small-business owners report payment averages over 31 days. Eleven (11) percent say that payment averages 46 days or more. With only a small number demanding payment in more than 30 days, a minimum of one in four average overdue payment. The figure is probably higher. As a result, approximately 6-7 percent of all small employers (11% of those invoicing) have a very serious slow or late payment problem. It is difficult to understand how these firms survive under the circumstances unless invoices constitute only a tiny percentage of payments or cash flow is exceptionally strong.
Third-party payers are even slower to pay than the general customer base. They average 34 days (Q#3e). However, the percentage averaging more than 46 days is actually somewhat smaller than among all customers (9% versus 11%). That means small-business owners dealing extensively with third-party payers must have a particularly strong cash position in order to do business with these customers.
The “sophisticated” business response to compensate for the financial problems created by late payment is charging interest on balances due, a late fee, or both. But the typical small business response is to charge neither. Sixty-three (63) percent say that they do not charge either a late fee or interest when a customer pays late (Q#3b). They effectively carry the customer without charge. There are exceptions. Seventeen (17) percent charge interest and another 11 percent charge a late fee. Only 8 percent charge both. The obvious question, of course, is why don’t they charge. The probable answer is fear of alienating customers. It may also be that some customers have market power at least vis-à-vis a small business and refuse to pay late charges or interest.
There are times when bills cannot be collected. So, many small-business owners feel compelled to turn over aged receivables to a collection agency. Comparatively few (29%) have a fixed schedule for doing so (Q#3c). The largest share turn them over after 90 days (13%) with a somewhat smaller group (11%) doing so after 120 days. Just 5 percent turn them over after 60 days. However, a plurality (34%) normally does not send overdue bills to a collection agency until they have exhausted all of their internal collection capabilities. While the data do not reveal how long that might be, the response sequence implies that the average time typically extends beyond 120 days. Finally, 28 percent say that they never turn over aged receivables to a collection agency. One possible reason for such a decision is that the owner is almost always able to work something out with customers who have overdue bills. Another less palatable reason is that the return after agency fees is not worth the resulting hassle and ill-will.
When small-business owners extend credit or terms, they typically extend it to customers in general. Fifty-two (52) percent report that they extend credit/terms to both individual and business customers. However, 28 percent do so only for their business customers and 15 percent do so only for individuals. The reason for distinguishing between the two is likely the frequency a customer does business with the firm. Repeat customers, particularly when sales to them are large, will typically have undergone some type of credit check. But, all factors equal, it does not appear that small businessmen and women prefer to extend credit more frequently to one group than another.
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Accepting Credit Cards
About half of all small businessmen and women now accept credit cards for payment (Q#4). Ninety-three (93) percent accept them on their business premises and 32 accept them over the Internet (Q#4a). However, the latter figure seems high given the number of small firms with Web sites and the Internet capacity to make secured financial transactions.
Small-business owners accept credit cards for several reasons, some related to payment and cash issues, but more related to marketing objectives. The most frequently cited reason for accepting credit card payments is that customers expect to be able to pay that way. Ninety-five (95) percent feel that customers expect to be able to pay by credit card and so owners accommodate them (#Q4bA). The second most common (79%) reason is that credit cards enlarge the firm’s market by making payment from a distance easier (#Q4bC). This is particularly true when the order comes from an area using a different currency, e.g., Canadian dollar. The third most frequently cited reason (69%) for allowing payment by credit card is that it improves cash flow (#Q4bB). The seller can claim his money immediately when paid by bank card, a far more desirable outcome than waiting for a check to clear. There is at least one important caveat to this general rule that will be noted later.
Other reasons are given for accepting credit cards, but they are cited less often. Thirty-nine (39) percent say an important consideration is reducing the amount of cash on the premises (Q#4bD). Credit cards reduce the problem in two ways. First, there is need for less change, reducing the owner’s bank costs as well as reducing security problems. Second, there is less need to house and deposit large amounts of cash that are taken in as payment. Protecting those sums can create notable security problems and costs. Twenty-three (23) percent say that credit cards, despite the associated fees, are less costly than other forms of payment (Q#4bE). For example, returned checks have costs; holds on checks constitute costs; even cash has costs such as the need to protect it. A non-trivial portion of those who take credit cards, therefore, feel they actually save money by doing so.
The other half of the small business population does not accept credit cards for payment. The most frequently cited reason for not doing so is that credit cards are not usually taken in that type of business. Thirty- seven (37) percent offer this “non-custom” reason (Q#4d). This response is particularly notable in the agricultural services, financial services and wholesale industries. The second most frequently cited reason is that the associated fee is an unnecessary expense (14%). These reasons were followed in frequency by no interest/need to take them (13%) and too much hassle (11%). Seven percent note that their customer base doesn’t use them. Thus, owners who do not accept credit cards simply feel that cards do nothing to improve sales. The issue to this group of small-business owners seems entirely about marketing and not the slightest about cash management.
Given the importance of habit and custom in the acceptance (or non-acceptance) of credit cards, it should not be surprising that their acceptance is highly industry specific. For example, large proportions of retailers and wholesalers accept them while they are rarely accepted in construction, agriculture, and the financial services. The large service industry is in the middle with non-professional services such as lodging and repair shops taking them often and professional services such as health care providers and lawyers taking them much less frequently.
Some small-businessmen and women mistakenly believe that if they accept credit cards and properly verify them prior to a sale, payment is automatic. Unfortunately, accepting a card even with verification is no guarantee that the seller will receive payment (in the longer term). A series of reasons, some for which the seller is not reasonably responsible, can prevent payment from being made. The important question is how often do small-business owners have card approval from the credit card company and subsequently have the company refuse payment. The answer seems to be not often. Three of four (77%) say that it did not happen to them in the last year. Eleven (11) percent say that they did one time and 5 percent say twice. But 3 percent indicate that it happened six times or more. While infrequent across the population, the circumstances surrounding the experiences of the 3 percent would be of interest.
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Checks appear to be the most common form of payment, even more so than cash. All but 5 percent of small-business owners report that they accept checks for payment (Q#5). Further, they customarily accept both business and personal checks (79%). Just 12 percent say that they accept business checks exclusively and three percent say that they accept personal checks exclusively.
Given that so many accept checks and bad or bounced checks is the second most often cited problem with getting paid, it would seem likely that most small businessmen and women would subscribe to a check verification service of some type. However, that does not happen. Only 7 percent of those accepting checks subscribe (Q#5a). Subscription is even low among retailers, those most likely to complain about bounced or bad checks. Likely reasons for not using the service include repeat customers, service cost, and the effectiveness of the service. Still, bad and bounced checks are highly annoying and costly despite the substantial fees usually charged customers for returned checks.
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One characteristic of America’s entrepreneurial society is that Americans are relatively likely to give people a second chance. Americans tolerate business failure more than people in most parts of the world. Nowhere is that more evident than in our bankruptcy laws. Bankruptcy laws in the United States are more forgiving of bankrupts than similar laws elsewhere. However, there are two sides to bankruptcy, even for business owners who are presumed to benefit more from liberal bankruptcy laws than perhaps any other group.
Thirty-six (36) percent report that they failed to receive payment at least once due to a personal or business bankruptcy during the last five years (Q#6). Of that group, somewhat more than three in four (78%) were hit by five or fewer instances (Q#6b). That means about three percent of the entire small-business population failed to receive payment in five or more bankruptcy cases over the last five years, or one or less than one case per year. The size of the average loss per incident is the critical element, however. As a result, it is not clear how badly small business was hurt in its creditor role by these bankruptcies. The frequency of occurrence would suggest that the damage was not great, but one large, outstanding bill lost in this way could prove very damaging.
Personal bankruptcies are significantly more frequent than business bankruptcies. The later, however, typically involve larger losses. The largest share of small businesses impacted are hit by business bankruptcies. Forty (40) percent say that they lost money from only business bankruptcies in the last five years (#6a). Another 33 percent say they were hit by both types of bankruptcies meaning that almost three-quarters experienced the impact of a business failure. In contrast, 26 percent lost money exclusively due to a personal bankruptcy and three in five lost money to a personal bankruptcy generally. This distribution is likely tied to the customer base, but it probably also reflects the larger average size of the losses generated by business failures.
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The owner is the person primarily responsible for maintaining the firm’s financial records in almost half of small businesses (49%) (Q#1). Someone outside the firm like an accountant or bookkeeper is the person second most likely (20%) to maintain them, almost identical to the number who have an employee perform the task (19%). Another member of the family including a spouse does it in about one of ten (11%) instances.
There is a clear relationship between the person who maintains the financial records and firm size. As ventures become larger, their owners are increasingly less likely to maintain the records themselves and increasingly more likely to have an employee do it. At least one point is somewhat surprising in this regard. Despite the fact that finance is one of the least favorite tasks of small-business owners, 35 percent of the owners of businesses with 20 employees or more continue to maintain the financial records. The time of owners of businesses this large seemingly would be put to better use on other tasks. Perhaps privacy concerns, information needs or the lack of a better alternative influences their decisions to hang on to the financial records-keeping function.
Maintaining financial records can include a number of specific tasks one of which is billing (invoicing) and, where necessary, following up to ensure a bill is paid. Seventy-two (72) percent of the time the same person who maintains the financial records is also the person who usually bills and collects (Q#1a). If the owner maintains the records, he or she also bills and collects in 89 percent of the cases. The only time the functions are not joined occurs when the financial records are maintained by someone outside the firm. In over 80 percent of those cases, the billing and collections function reverts back to the business. When customers are delinquent, therefore, the owner frequently is the one who must divert time from more productive purposes to collecting overdue bills.
Another task that is usually part of the function of maintaining the financial records is primary responsibility for the most common interactions with the firm’s financial institution(s) such as making deposits or getting change. Seventy (70) percent say that the person who has primary responsibility for the former also has responsibility for the latter (Q#1b). These data re-enforce the idea that the billing and collection function is integrated with the other basic financial functions in most small firms.
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Customer slow and/or late payment creates serious problems for many small businesses. To reduce the problem, small businessmen and women must recognize the source of their problem and respond accordingly. The average time between invoicing and payment argues that some response, like more frequent, immediate payment, would be a helpful first step for many owners. But immediate payment isn’t always practical for either the seller or the buyer. It is not coincidence that certain forms of payment became traditional in certain industries. They developed because they proved to be the most satisfactory for the parties involved. Change in the relative satisfaction of the parties, such as business owners becoming increasingly concerned over their receivables problem, may lead to an alteration of commonly accepted practice. But, the side wanting change is the one who needs to press the issue. That means small-business owners need to be the one pressing change to more immediate forms of payment.
The natural concern is that changing customary terms of payment may adversely affect sales. Customers, effectively, would be less likely to buy if the payment conditions were less favorable. Sales losses are a legitimate concern given that the terms of payment are as much a part of the sales transaction as other aspects of it, e.g., delivery, warranty. The task of the small-business owner is to determine just how sensitive customers really are to the terms of payment, and if they prove to be, whether the loss of their business is worth acceleration of the revenue stream. Just how aggressively one needs to pursue this step depends on the severity of the problem’s impact.
The challenge is similar in pursuit of delinquent bills. There may be some tradeoff with sales, particularly if the situation is not handled well. But here the small-business owners have the moral and legal “high ground” in contrast to establishing the terms of payment which essentially is an agreement of participating parties.
The immediate challenge is that the slow payment problem generally grows worse in a poor economy. Sales are fewer and harder to come by. Meanwhile customers often extend their payments due to more difficult financial conditions at the same time creditors are more attentive to their own receivables. The resulting squeezes and trade-offs small-business owners experience are no different than those experienced in a normal, growing economy. They are simply more severe and occur when their own financial conditions are likely to be declining (at least relatively).
Credit cards are accepted widely within the small-business population. Broader acceptance outside the industries where they are traditionally found is another possible response to the slow pay problem. Certainly the relatively recent appearance of credit cards in places like doctors’ offices show that they can be effectively employed in places outside the travel and retail industries. However, credit cards also are not always the answer either. The fee may not be worth the losses from slow payment and neither may the inconvenience and hassle.
A second major concern of small-business owners with payment is bounced and/or bad checks. Checks are predominantly a problem for retailers. Small retailers rarely invoice or extend credit. As a result, difficulties arising from slow pay are minimal. Since most retailers accept personal checks (with the proper identification), checks are the place in a retailer’s payment structure where problems could conceivably arise and do. Check verification services apparently are not very helpful or they would be used more than they are. Credit cards, and preferably debit cards, are alternatives where not currently used. But the decision to allow checks for payment must balance the possible loss of sales against the losses from bad and bounced checks.
The direct losses small businesses incur from bankruptcies do not appear to be great, though additional data would be helpful. Losses due to bankruptcies occur relatively infrequently, though a huge loss just once could have a significant impact. While many small-business owners appear sympathetic to the creditor view of bankruptcy legislation, their outlook appears as related to publicized abuses and other matters of principle as it is to personal experience.
Finally, the issue of partial payment was scarcely noted, but is of particular interest to a core group of small-business owners. The issue largely involves disallowed expenses or charges or after the fact price changes. These situations tend to occur when a small firm is being paid by a third party or has a contract with a large customer needing to cut costs.