A good way to increase sales – one that’s overlooked by many small businesses – is to extend credit to your customers. Unless they are very affluent, there’s a good chance your customers are concerned about cash flow. And that means they won’t make as many purchases as they want to. But if they can buy from you and not have to pay for their purchases up front, they might buy substantially more. Or they might choose to buy from you rather than from a competitor who does not offer financing.
Either scenario could greatly increase your profits. Yes, there are headaches in collecting what is owed to you – and there will almost certainly be some defaults. But on the plus side, you can probably collect a favorable interest rate on the credit you extend. So if that extra profit, plus the extra profits from increased sales, exceeds the cost of servicing the accounts, it may be a prudent move for you to make. In order to extend credit, you must be in a position to do it without ending up in a cash crunch of your own.
Like many small business owners, you probably don’t have the capital available to keep purchasing inventory and then wait for payment. But there are a few ways that you might be able to do it. If, for example, you sell an item with a high enough profit margin, you can offer to finance a large portion of the price. I was once in the retail jewelry catalog business. Our marketing “hook” was that we guaranteed to finance anyone. The way we did it was by collecting a down payment that covered the bulk of our product cost. That meant we could immediately replenish our inventory.
In this instance, the customer made a down payment of 25% of the retail price, and we financed 75%. This allowed us to recover close to all of our inventory costs up front. Then, the monthly payments we received from the customer were pure profit. The interest rate we charged allowed for enough extra income to cover any collection and charge-off costs. Another possibility is to finance your inventory and lease it to your customers at a higher rate than what you’re paying.
Years ago, I worked in the “rent-to-own” industry, where credit is extended to customers who have the worst imaginable credit records. Customers with bankruptcies, auto repossessions, home foreclosures, and everything else are welcomed with open arms. In fact, these companies don’t even run credit checks. What they do is collect enough personal information about the applicant to determine his stability factor – the likelihood that they will be able to find him and recover the merchandise if he stops paying.
With their aggressive policies, well-managed rent-to-own companies operate with about a 5% default rate. Because the merchandise is easily collateralized, they borrow at reasonable interest rates – but the customer winds up paying them approximately 300% of the retail value of the item. It’s not hard to see how these companies can make a very high rate of return on their merchandise. There’s one more way to extend credit to your customers that you may not have thought of …
If you have credit-worthy customers (and a good lawyer to help you write up the contracts), you can write the paper (extend the credit yourself) and sell it to a business that buys installment loans. Or you can arrange for a third-party lender to write the loans for you from the start. Naturally, the above strategies work only if you sell directly to end-users rather than to businesses that resell your products. The bottom line is this: If you are looking for a way to stimulate sales, extending credit may be a viable option for you – no matter how small your small business is.
(Ed Note: Paul Lawrence is an entrepreneur and the creator of ETR’s exciting new Microbusiness Program. Please click here for more information about how to get a small business started on a shoestring.)