
As a small business owner, choosing the right supplier is crucial. Often, the decision boils down to selecting between two indistinguishable options, with price being the deciding factor. While it seems logical to choose the cheaper option, there is a hidden secret that could make the more expensive supplier a better choice for your bottom line. In this post, I'll explain why opting for a pricier supplier can actually boost your profits.
The Hidden Secret: Payment Terms
Consider two suppliers offering the same product and service: Supplier A charges £100, while Supplier B charges £105. At first glance, Supplier A seems like the obvious choice due to the lower price. However, there's a crucial factor to consider: payment terms. Supplier A offers 7-day payment terms, while Supplier B offers 30 days end-of-month payment terms.
This seemingly minor detail can have a significant impact on your business's cash flow and financing costs. The 5% price difference might initially seem like an unnecessary expense, but let's break down why this could be the cheapest loan you'll ever get.
As a general rule, this applies to suppliers you buy from regularly and will almost always owe money to.
The Cost of External Financing
If your business relies on any form of external financing, such as an overdraft, a director's loan, asset financing, or even a bounce-back loan, you're already paying interest. In 2024, commercial interest rates range from 8% to 12%, depending on the finance product. Compared to these rates, the 5% "extra cost" of Supplier B’s longer payment terms is a bargain.
By choosing Supplier B, you're essentially receiving a 60-day free credit period. This extended payment term allows you to better manage your cash flow and reduces the need for more expensive short-term financing.
Maximising Cash Flow Benefits
Timing your purchases perfectly can enhance these benefits. If you don't have to pay Supplier B for 60 days, you can keep that money in your bank account longer, potentially earning interest. With current interest rates, you could earn around 5% interest on that money, offsetting the additional cost of Supplier B.
It's crucial to include the cost of effective interest in your calculations when assessing the true cost to your business. By factoring in the savings from reduced financing costs and the potential interest earned, you might find that Supplier B's higher price actually results in lower overall expenses and increased profitability.
Conclusion
While it may seem counterintuitive, choosing a more expensive supplier can sometimes be the smarter financial decision. By considering payment terms and the cost of external financing, you can make a more informed choice that benefits your business in the long run. The next time you're faced with selecting a supplier, remember to look beyond the price tag and consider the broader financial implications. You might just find that the more expensive option is the key to greater profitability.
Comments