When a business runs short of cash, it's common for the owners to start paying bills late—sometimes even federal and state taxes.
First, you should know that skirting tax obligations is an absolute no-no and a sign that you may be at (or past) the point where you should close down. But if you're unconvinced, see our article on prioritizing your debt payments, which explains why shortchanging the IRS is a terrible idea.
Even paying garden-variety bills late is almost always a poor approach, for all the reasons discussed below.
Why Paying on Time Makes Sense
What about the argument some small business commentators make that by keeping accounts current you are paying out money before you absolutely have to—something you can't afford to do in tough times? Sorry, in the real world of small business this may not make sense for six reasons.
Saving Your Good Name
The cost of paying on time is low as compared to almost anything else you can do to maintain a good reputation in your business community. When you pay late, you kick your cash problem down the road a few months at great cost to your credibility, something that is crucial to preserve in tough economic times. To survive, your business will eventually have to pay its debts, so by putting them off a few months you gain nothing but risk losing your good reputation.
Paying early can get you discounts that net you more cash then you could earn in interest by holding onto the money longer. Don't be shy about asking for deeper discounts than your vendors initially offer. Especially if you have the cash to pay early, you should be able to achieve reductions as high as 10% to 15%.
EXAMPLE: A few months after the recession hit and new construction plummeted, Solar Supply LLC's bank threatened to pull its line of credit. This was avoided when the company's founders loaned Solar Supply a substantial sum. Now with both the loan money and line of credit to draw on, Solar Supply had adequate cash, but no profits. So after making lots of money-saving cutbacks, Solar Supply called its ten largest vendors with a simple proposition: For the next six months, Solar Supply will pay on delivery for all orders, in exchange for a 15% discount. Five vendors—themselves short of cash—immediately agreed, and two more said yes when it became clear they would otherwise lose the business. The three holdouts were easily replaced by companies that realized that when times are tough, everyone has to give a little.
Ensuring Excellent Future Service
Every working day, you (and every other small entrepreneur on Earth) form judgments about the businesses you come into contact with, judgments that are particularly crucial at a time when many businesses are in financial trouble. For example, you likely have thoughts like these on a regular basis:
- Business A produces a reliable product.
- Business B's employees can be relied on to show up when they say they will and work overtime if that's what it takes to finish a job.
- Business C constantly comes up with new and innovative services that frequently anticipate our needs.
- Business D always seems to be understaffed by surly employees who never return phone calls.
- The owner of Business E is great, but some of his younger employees are not properly trained.
- Damn Business F. Another day is here, and its check isn't.
When these thoughts run through your head, you'll doubtless question whether you ever want to deal with business D, E, or F again. And if you had to choose one of these less-than-stellar outfits to head your blacklist, we bet it would be Business F. That just makes good sense. Tough as it is to cope with late deliveries, unreturned phone calls, inexperienced workers, or even poor quality products or services, it's far harder to survive without being paid. This is doubly true for a business in a field where payment isn't due until after goods or services are provided. Here, if payments are substantially late, a business can actually fail even though its bottom line shows it to be profitable.
You want to be a company that other companies want to do business with. For example, if your business suddenly needs to ask a print shop to turn around a flyer in a few hours, you'll have a much better chance of getting them to say yes if you paid your last bill the day it was due.
Encouraging People in Your Network to Recommend Your Business
Keep in mind that it's not just your satisfied customers (people who pay you money) who tell others about your business. All the people who work for and with you can also be powerful recommenders. This includes everyone you cut a check to, from your landlord and insurance broker to the owner of the restaurant down the street that occasionally caters your meetings. If they feel positive about your business—something that is greatly aided when you pay their bills promptly—each can become a significant marketing ally.
EXAMPLE: Doug, an insurance broker, goes to great lengths to help Bluebelle Web Design find an insurance company willing to customize a standard business policy to meet Bluebelle's special needs. Joan, Bluebelle's president, is so impressed with Doug that after the policy is finally in place and Bluebelle is billed, she ignores the ten-day payment terms and immediately mails the premium check, along with a note of thanks. Now it's Doug's turn to be pleased. Later that week, when he attends a service club meeting and the subject of small business websites comes up, he favorably mentions Bluebelle to what amounts to a roomful of potential customers. As a result, Joan picks up two excellent new accounts.
Building and Keeping a Positive Credit Profile
If your business is new and tiny, you might assume the rest of the commercial world doesn't even know you exist. Not so. Almost from day one your small business will leave tracks in the commercial sands. For example, if you incorporate, form an LLC, hire employees, or apply for a bank loan, credit card, or trade credit, you'll quickly appear on the radar screen of Dun & Bradstreet and similar data collection organizations. These outfits gather and sell credit information about virtually every American business. Among other things, they note what your business does, how many employees it has, who owns it, and, probably most important, its credit and bill-paying history. In short, your bill-paying profile is available to anyone who pays a modest fee.
Who would buy such a report? Especially when economic times are tough and many businesses are losing money, the answer is: Virtually all of your creditors and potential creditors, including banks that are considering lending you money, companies reviewing your application to lease equipment, and suppliers, wholesalers, and other businesses from which you have requested credit. True, an excellent payment record alone won't guarantee that you'll receive a bundle of commercial credit or a particular loan; other information is also important. But if Dun & Bradstreet reports that you habitually pay late, your credit application is sure to raise a red flag and greatly increase the likelihood that you'll have to pay cash up front.
Getting a Payment Cushion
Paying on time acts as an effective rainy day fund if and when you face a serious reverse like losing a major client, having a horrible sales month, or dealing with the bankruptcy of someone who owes you a lot of money. That's because in case of emergency, you'll have a payment cushion of several months: If you've paid promptly over the years, you'll have built up a substantial reservoir of goodwill and respect with creditors. They are likely to support you when you can't pay on time if you can show them a convincing plan to solve your temporary cash problem.
EXAMPLE: Frank's Marine Services, a long-term customer of your engine repair business, faces a difficult business patch because a charter company went bankrupt owing it $40,000. Frank has always paid you early or on time, so chances are you will be as accommodating as possible—certainly far more generous than you would be if Benji's Boat Repair, your most feckless customer, asked for similar help.
What to Do When You Must Pay Late
Sometimes, despite your best efforts, you might not be able to pay all your bills on time. For example, you might be forced to delay some bills a month or two while you deal with a one-time problem like a lost line of credit, a tax lien, or closing a money-losing part of your business.
In this situation, your best strategy can be stated in three words: communicate, communicate, communicate. Don't wait until you receive a third dun letter to talk to the people whose check is not in the mail; pick up the phone as soon as you know you have a problem. Talk to the person who has real authority to manage accounts receivable to briefly explain what the problem is, how you're solving it, and when you expect to be able to pay. If you can make an immediate partial payment, even a small one, it's absolutely essential that you do so. As the old saying goes, it always pays to put your money where your mouth is.
Don't overdramatize your business problems. Occasionally, people who can't pay a bill on time are tempted to detail every miserable thing that prevents them from doing so. Better to briefly explain a good reason for the holdup and focus on when you will be able to send a check. Otherwise, you risk convincing the creditor that things are so bad they should immediately cut off future credit.
For information on which bills you should pay first (to reduce your liability), see Nolo's article on Prioritizing Which Business Debts to Pay.