Three Core Contract Terms to Protect Your Cash Flows
The global economy has weathered some major obstacles over the past two years, from the Covid-19 pandemic to the Russian invasion of Ukraine and its effects on international trade.
It’s always a good idea to be prepared for market volatility, whether it’s a cyclical recession or a temporary blip in the stock markets. When the economy slows down, liquidity becomes more important than ever. Accordingly, a central part of preparing for economic uncertainty is getting your organization’s cash flows in order.
Your contracts are the core source of information on all of your business dealings, both as a seller and as a buyer. The terms in your commercial agreements dictate everything from how much revenue you’ve earned for your work to the specific instructions you need to follow when submitting payments for things you’ve bought.
Managing your contracts is key to managing your cash flows.
Here are three types of contract clauses that directly impact your organization’s cash flows:
Payment terms are among the most basic, but also vital, pieces of information in your contracts. Whether you’re the buyer or the seller, you need to know exactly how much money the purchasing party owes to the vendor, when those payments are due, and what sorts of rights and protections each party has, from discounts for the buyer to remedies the seller can pursue if the buyer fails to pay.
It’s always important to keep track of your revenues and expenses, but it becomes even more urgent when revenues and market conditions are less predictable. Your team needs a fast, reliable way to locate and track the payment terms throughout all of your business’s contracts — and the more contracts you have in place, the more urgent that need becomes.
You don’t want to get stuck manually searching for a way to temporarily defer payments at the last minute, or discover after the fact that you missed the opportunity to cash in on a discount or collect extra payments. Do you have a way to keep track of all of the payment terms throughout your entire contract portfolio?
When you’re trying to protect your cash flows, two particularly helpful types of payment terms to track are early payment discounts and late payment penalties.
Early payment discount
Also known as a “cash discount” or “prompt payment discount,” this type of clause allows buyers to save money by making early payments.
This arrangement is good for buyers that have sufficient reserves of liquid capital and want to minimize long-term expenses. By paying in advance, they reduce the total amount they pay over the life of the contract. If you have the cash to pay now and you’re uncertain about the possibility or duration of an upcoming economic downturn, then you might prefer the security of paying off the contract while you know you can, coupled with the knowledge that you’ll save money later.
Sellers also benefit from giving buyers early payment discounts. When the economy slows down, the likelihood of missed payments and defaults goes up. Incentivizing early payments helps vendors to secure revenue today, effectively mitigating losses before they start.
Parties on both sides of the exchange should keep track of available discounts. If you manage vendor relationships as a buyer, taking advantage of cash discounts today can give you some breathing room if you have less room in your budget several months from now. If you manage customer relationships as a seller, proactively bringing these discounts to your customers’ attention can help you boost your revenue and give you more working capital heading into a period of potential turbulence.
Does your contract management system automatically track terms such as payment discounts so you don’t have to?
Late payment penalty
If a buyer is in the opposite position and doesn’t have enough cash to make payments on schedule, the contract will typically lay out terms to govern how the parties handle the failure to pay. Most parties won’t want to end a business relationship over a brief delay in payments, so a better alternative is to provide a predetermined late payment penalty.
After the buyer catches up on the late payments, along with additional fees, the parties can continue business as normal. The seller retains a customer and gets some additional revenue to make up for the delay, and the customer still has access to the goods and services they need.
It’s imperative to be able to find this information promptly, on demand. The more vendors and customers your business adds, the more challenging that becomes. Do you have a quick way to review your obligations as a buyer or your rights as a seller following a late payment under any given contract?
Effective contract management is key to effective cash flow management, especially when money is tight.
These different types of payment terms aren’t the only clauses in your contracts that can directly affect your business’s cash flows. Read our full guide on contract terms to track for cash preservation, and learn how Evisort can help.
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