Deferred payment: the secret of efficient cash flow

Perhaps you’ve already heard the phrase, cash is king! Companies need consistent cash flow to run their daily operations. Despite the numerous options for funding a business, without proper management, a company can face liquidity issues.  

As a small business owner, you might have spotted a perfect piece of equipment to boost your operations further. However, upon a glance at its price tag, it sends a jolt through you. With limited cash, paying for this equipment could burn a hole in your pocket. So, what can you do?

This is where deferred payments shine. Similar to the “Buy Now, Pay Later” model, this strategy helps businesses make better use of their limited resources. But what is a deferred payment? How does it work? Are there pros and cons to using this financing option? This expert guide explores how this method can be a game-changer for SMBs. 

What is a deferred payment?

Deferred payment is the delay agreed by the buyer and a seller (or creditor) to allow payments for a good or service to be made later. This concept enables businesses to spread costs over an agreed period.

The dream of any business is to scale up. However, according to Zippia reports, 82% of small businesses today face the issue of cash availability. Indeed, companies want to purchase products or services that can keep them ahead of the competition. 

Yet, with limited resources, such dreams may not materialize. However, deferred payments help solve the problem. It’s a convenient approach for businesses that want to stay liquid and manage simple cash flows without needing invoice discounting.

Different structures for deferred payments

Depending on the type of lender, there are often different structures for deferred payments in terms of:

Installment plan

In this arrangement, total payment is broken down into small, manageable amounts over a stipulated timeline. This allows for the spread of financial burdens and the possible purchase of needed items.

Balloon payments

In this plan, the company pays small amounts during the deferral period but clears off the massive balance at the end. This is suited for a business that expects a hefty inflow of cash in the future due to an increase in seasonal sales or the conclusion of a big project.

Interest-free periods

Sometimes, the contract terms may be such that no interest is levied for a particular period on the deferred amount. This benefits startups and SMBs looking to conserve capital while ramping up operations or launching new products.

How does a deferred payment work?

No doubt, you now understand deferred payments and its various structures. But then, how does a deferred payment work? Let’s consider these five key steps:

1. Identify a potential lender

A business first identifies the product or service it needs and researches its funding options. Then, it looks for lenders specializing in SMB financing and compares their rates and repayment terms.

Learn more: 6 options for funding your business.

2. Agreement

The buyer and seller must agree to the terms of deferred payment. This agreement can be formalized in a contract or agreement and may include the payment amount, the due date, and any interest at the end of the deferral window.

3. Delivery

Per the agreed terms, the seller provides the goods to the buyer. The buyer then uses the purchased item to boost their operations without hassle.

4. Payment deferral

While the buyer doesn’t make the full payment upon purchase, they do so later. This can be paid in installments or as a whole.  

5. Interest and fee

Per the formal agreement, the buyer may need to pay interest or additional fees to have the privilege of deferring the payment.

The structure of deferred payment plans can vary, but let’s revamp the previous scenario, assuming the equipment’s price is $50,000. As paying the total amount as a business owner may be difficult, you and the seller can agree to a deferred payment plan.

Under this plan, you consent to spreading the cost over ten months, making payments of $5,000 per month. Any interest or fees will be discussed with the seller and must be included when paying installments.

Common deferred payment examples

To illustrate the practicality of deferred payments, let’s discuss real-world examples.

Inventory purchase for a retail business

Consider a small retail business preparing for the holiday shopping rush. The owner needs to make a large purchase of inventory to meet demand. Instead of upfront payment, the supplier agrees to deferred payment with 60-day terms.

In this case, the retailer will stock up enough inventory during off-peak seasons by employing smart inventory management strategies to optimize storage and minimize costs. Then, they sell products at peak times and use the revenue from the sales to pay the supplier. This generates an advantage for the business since it’s well prepared for busy months without undue strain on its cash reserves.

Seeking how to handle your inventory during off-peak periods? Learn winning inventory management strategies for holiday seasons.

Equipment upgrade for a manufacturing company

A medium-sized manufacturing firm needs to upgrade its machinery setup to increase production capacity. The cost of new equipment hovers around $200,000, which is quite large and must be paid immediately by the company.

The supplier then works with a deferred payment plan for monthly installments over 24 months. Such an arrangement allows the manufacturer to use the equipment for production and generate income within two years. Consequently, they can repay their agreed monthly debts. 

Marketing campaign for a tech startup

A tech startup is about to release a new product and needs to invest in serious marketing. The marketing agency provides a $50,000 service but allows the startup to defer the six-month payment. This option allows the startup to generate revenue from its product launch and pay for the marketing costs. Ultimately, this eases the financial burden during a critical growth phase.

What are the advantages of deferred payments?

The advantages of deferred payments are connected to making expensive purchases more accessible, allowing businesses to spread the cost over time. This financing option can prevent strain and make budgeting easier. Here are some advantages it offers.

1. Improved cash flow

Cash flow management is a constant juggling act for any small business. Payroll, inventory, marketing, rent – the list goes on. Deferred payments offer a strategic solution, as it distributes the cost of a purchase over time.

Imagine a clothing boutique facing seasonal fluctuations. This financing option allows them to strategically stock up on winter wear during the off-seasons and maximize sales opportunities at the right time.

Facing cash flow problems in your SMB? Discover four ways to prevent cash flow problems in your business.

2. Flexible financing

Traditional loans and credit lines can feel like a complex maze for small businesses. Deferred payments offer a more seamless path. The application process is usually simplified, and the loan has a fixed interest rate, which enables a business to plan its financials systematically.

3. Enhanced buying power

That top-of-the-line equipment may seem very far away. This financing tool gives your business the power to invest in assets that once might have been out of reach. Acquiring these resources can enhance your business output.

4. Simplified budgeting

Budgeting can constantly challenge small businesses, especially with fluctuating income streams. Deferred payments introduce an element of predictability. With fixed monthly installments, you know exactly how much will be repaid. This allows you to allocate the remaining cash flow more efficiently.

5. Strengthened supplier relationships

Deferred payments help foster stronger relationships with your suppliers. By meeting deadlines, you make your business attractive to the lender. This could mean better pricing terms, priority service, or exclusive deals in the long run – a win-win proposition.

What are the disadvantages of deferred payments?

Like any financial strategy, deferred payments have two sides: the good and the bad. Understanding both sides can help companies decide whether to use this option or other avenues. Here are some disadvantages of this strategy.

1. Interest and fees

Let’s face it – nothing comes for free. In most cases, deferred payments have interest and charges, which increase the total cost compared to paying at the time of purchase. So, while the business gets the advantage of deferring costs, there’s no free lunch.

2. Debt accumulation

Deferred payments can lead to debt accumulation if not managed properly. It becomes overwhelming if a business is juggling multiple deferred payment plans.

3. Credit risk

Suppliers or lenders might impose stricter credit terms or require personal guarantees, particularly for SMBs with limited credit history.

4. Dependency on cash flow 

The ability to meet the deferred payment obligations highly depends on consistent cash flow.  If your business experiences a sudden drop in sales, it becomes difficult to make monthly payments.

To summarize, here’s a table highlighting the perks and drawbacks of deferred payments:

Pros

• Improves cash flow for businesses
• Allows flexible financing
• Enhances purchasing power
• Simplifies budgeting
• Strengthens supplier relationships

Cons

• Interest is added to each installment payment
• Could lead to debt accumulation
• Dependent on consistent cash flow