Goods bought on credit: where the risk lies

Buying goods on deferred payment or with bank credit turns a stock question into a debt question. If the goods sell, all is well: the money arrives and the debt is cleared. If they do not, the payment date still comes and the loan interest runs every day. This article is management advice for a warehouse manager, not financial advice: go through the terms of the credit and the deferral with your finance specialist. The figures are illustrative.

The basic rule

The selling time of goods bought on credit must be shorter than the repayment term. A short sentence, but in practice many people check it for the whole batch, although goods do not all sell at the same speed.

An example, hypothetical. A batch worth 600 million so'm is bought on 45 days' deferral. The batch has three groups:

• fast goods: 300 million so'm, sells in 20 days;
• medium goods: 200 million so'm, sells in 60 days;
• slow goods: 100 million so'm, sells in 150 days.

How much comes back at cost by the payment date, day 45? The fast goods in full: 300. From the medium goods 45/60, or 150. From the slow goods 45/150, or 30. A total of 480 million so'm. The amount due is 600 million, so the gap is 120 million so'm: 20 percent of the batch must be covered from another source. Adding margin shrinks the gap a little, but the direction does not change.

Why slow goods are costly on credit

Slow goods cost more than their price: interest and storage work every month.

Let us continue. The slow group is 100 million so'm for 150 days (5 months). Say credit costs 2 percent a month and storage and loss 0.6 percent a month (both figures illustrative). Interest: 100 × 2% × 5 = 10 million so'm. Storage: 100 × 0.6% × 5 = 3 million so'm. A total of 13 million so'm, or 13 percent of the batch value. If the margin on this item is 15 percent, only 2 million so'm of profit remains. And if a 10 percent discount is needed to sell it, the batch closes at a loss.

Fit the order to the payment term

Derive the order size from the sales speed:

what can be sold before payment = daily sales × payment term (days)

For example, an item sells 25 units a day on average, the payment term is 45 days: 25 × 45 = 1,125 units. Every unit beyond that will still be in the warehouse on the payment date, and the money must be found elsewhere. For safety you can limit the volume to 70 to 80 percent of this figure: even if demand drops, a reserve for the payment remains.

Group the goods:

• fast and steady goods: can be bought on credit, fitted to the payment term;
• medium goods: small batches, more frequent orders;
• slow goods: do not buy on credit; buy to order, or with your own money and in small volumes.

The contract and the partnership

Try to link the payment terms to sales:

• take the batch in stages rather than all at once;
• split the payment into parts, paying the last part after the sale;
• a right to return or exchange unsold goods;
• take goods on commission (consignment): you pay for the part that has sold.

If the credit is from a bank, the goods may be pledged as security; in that case a lawyer should review the terms on selling and reporting.

The control sheet

Once a week look at two things side by side:

1. The payments calendar: how much falls due on which date.
2. The balance and age of goods bought on credit: how many days they have been in stock and how many days remain to payment.

A simple signal: half of the payment term has passed while less than 40 percent of the batch has sold. In that case begin talks about a discount, selling in sets or a return before the payment date, not after it.

An example: a batch of 600 million so'm with a 45-day term. If by day 22 or 23 less than 240 million so'm at cost has sold, the signal lights up. Let three people review the sheet together: the buyer shows the order, the storekeeper the age of the goods, the finance person the payments calendar, and the decision is taken in one place.

Conclusion

Assess goods on credit item by item, not batch by batch, and fit the order to what can be sold before payment. The OmborExpert specialists can help analyse the age of batches, calculate order sizes and set up the control sheet.