What are the pros and cons of selling goods on credit?
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Accrual basis (selling goods on credit) generates more income because you offer customers credits to buy the goods from you. You will have more sales when you sell because people like to purchase on credit because they have some time to pay.
Increase in income and profit.
Of course, when you write your sales records, the income has increased, showing that your profit and loss accounts offer a more significant profit.
Cash flow
But we must consider reality. Do we have enough cash? The answer is no; the consequence is that you will face a cash flow problem and run out of working capital.
Working capital
So, you might need help running your business and looking for outside funds to supplement your cash flow. If you don’t have enough working capital, you will face many problems, such as fewer sales, supplier payments, and workers.
That shows the difference between cash and profit, so entrepreneurs must consider that without thinking that their business is doing well. You can decide whether the company is doing well once you receive customer payments.
Selling goods on credit
The accrual basis means you sell products on credit. It is my question for you.
Do you think all your credit customers will make payments on time?
What will you do if some of them do not pay you the money they owe you?
Bad debts
My answer is that you have put your small business in big trouble. That results in facing two immediate issues: first, you will face cash flow problems, and second, your profit will go down because you must write off some of the sales from your income account. Then, your business might show a loss that will have another effect: if you want to get a loan from a bank, they will refuse after looking at your profit and loss account.
Finding funds to cover the loss
When you produce a profit and loss account, the bank or lender will look through the accounts and refuse to give you the loan. The next option will be to borrow from your friends and relatives. Even they might refuse because they have lost confidence in you and your business. Therefore, any company that looks good on credit must have a contingency fund.
Internal control
Therefore, credit sales will improve sales, and proper internal control is needed to prevent losing money. It would help if you considered these facts before selling on credit.
- Implement invoice system
- Choose the customer to give credit.
- Invoice immediately.
- Send reminders and follow it up.
- Do you have a contingency plan to meet the shortfall in funds?
Pricing
The best option for increasing sales in a small business is to monitor the profit margin when setting the price.
When you calculate the profit margin, for example:
Sales $750,000
Costs -300,000
Profit margin ratio – 750,000-300,000 = 450,000
450,000/750,000 = 60%
When you notice the sales are declining, start offering discounts and selling in cash. Then, the customers will move on to you to get the deal instead of going to the competitors.
Pricing a product is crucial; when you sell goods in cash, the price must match your costs and make a little profit if you want to make a higher sale. However, accrual-basis credit possibilities have a higher sale, but consider the risk involved, which I have mentioned above in this article.
Claiming Tax Deductions
The method you choose can affect your business. It will involve the tax year and consider the income and expenses in that particular year.
You cannot claim tax deductions if you incur expenses in one year and did not pay that year. It applies to the cash method; you will claim the tax deductions the following year. It is different in the accrual method because you record the transaction as and when you enter. Therefore, regardless of the money received, you will claim the tax deductions in the same year.
When you sell on credit, you get a competitive advantage because customers will prefer your business as they can have some time to make the payment. However, when some of them find it difficult to pay the invoice on time or may not pay at all, the relationship you developed by offering credit sales will become strained.
In conclusion, selling goods on credit has pros and cons. You must immediately correct the mistakes and prevent the business from going down.