by: Chris Kane
“Anytime you can sell ahead of your expenses, do it.” -Gary Vaynerchuk
Get paid now, provide the product or service later.
When businesses are able to do that, it can provide numerous benefits. Not only can these benefits improve the financial health of an organization, they can be used as advantages that can set them apart from competitors.
For the most part, obtaining payment upfront is the optimal situation for a majority of businesses. However, it can be difficult or near impossible to orchestrate in many industries.
Take the restaurant industry for example. Would most restaurants prefer to be paid for their products upfront? Overwhelmingly, yes. With lower margins than other industries, the ability to have sufficient cash on hand is essential. Restaurants have to buy and store perishable goods before a sale. If they don’t make a sale within a reasonable amount of time, the cost of those goods eats into their profits. Having a surplus of cash on hand to cover those costs, as well as many of the other expenses that contribute to their lower margins, would be a game changing advantage for them.
An industry that already orchestrates upfront payments effectively is the Saas industry (Software as a Service). Saas solutions offer monthly subscriptions at one price and then annual subscriptions at a discounted price.
When a customer buys an annual subscription, not only does that guarantee that person will be a customer for a year but the company also get the money now, for which, they would have had to wait month after month for.With products that are not perishable within a week or two and a standardized way to obtain upfront payments, these companies reap the benefits on multiple fronts.
So, when a company is able to obtain payments upfront what kind of benefits should they expect?
1. Increased Cash FlowWhen a business is paid upfront, they are free to do with that cash as they see fit. Although you can’t recognize it as revenue right away (it hits the balance sheet as a deferred revenue, which is a liability until recognized), that cash is there and available. Furthermore, the transaction processing time of 2–3 days is nothing compared to the months it would take otherwise to secure the same amount of money from that customer.
Businesses need to sustain sufficient cash flow, which can be more crucial than larger profits and sales numbers. Moreover, a surplus of operating cash flow can substantially improve the financial health of an organization, as well as send positive signals to investors if the company is publicly traded.
Let’s look at an example:
Via their app, Starbucks has managed to secure over $1.171B in upfront payments as shown on their FY2016 10K under store card liability. That is a massive advantage over everyone else in their industry. Even more than getting paid upfront, customer prepayments guarantee that they will return to spend the remainder of the balance or Starbucks’ gets free revenue.
2. Retire Debt
Aside from covering operating expenses such as inventory, once upfront payments are received a company could opt to use them to retire outstanding debt. If your loans permit prepayments, paying down your principal early will result in lower interest thus saving you more money.
Another option is to invest the excess money. Invested in a moderately conservative portfolio, one could expect to earn a yearly return of 7–8%. Now, there is the potential to make even more money on funds you would have never even had in the first place.
Furthermore, a business could choose to avoid the financial markets and invest in other means like people, new hardware/software, new locations, etc. They could make that key hire sooner, buy new computers, purchase new software to replace outdated systems, take a risk in an untapped market or medium, or provide awesome perks to their current employees to show them they are cared about and valued, further increasing productivity and retention.
4. Residual Profit Boost
For companies receiving upfront payments in the way Starbucks’ does, they can expect to receive a small profit boost from the capital that is not redeemed after a reasonable period. If a customer never redeems their prepayments, the money just doesn’t sit in deferred revenue forever. After a reasonable period, it can be recognized as revenue. Resulting in free revenue for the company. The cash has always been there but now the top line revenue, as well as net income can show a nice bump from those funds.
5. Cheaper Transaction Costs
When customers pay with a credit card, the credit card or payment gateway companies charge a fee which is usually a percent of the transaction plus approximately 30 cents. If we knew for certain a customer was going to spend $100 dollars at your business this year, it would cost you more to receive that $100 in $25 increments, opposed to all at once, because of the 30 cent fee. In this example, an extra $1.20 may not seem like much, but at scale it adds up. Save that money by getting paid upfront.
6. Streamlines customer experience
When a product or service is already paid for, it removes an extra step for the customer. Whether that step is physically paying for the product/service by taking out cash or a card, or avoiding the mental taxation on a customer by the thought of that money leaving their bank account, it improves the customer experience.
7. Psychology of a prepaid balance
It is important to consider the psychology of having a prepaid balance. When using a prepaid balance, the customer does not feel like he/she is spending money.
There is a mental disconnect between the user’s balance and actual money being spent. In the mind of a customer those prepaid funds are already gone and the emotional effect of parting with something diminishes over time. Therefore, in a Starbucks’ scenario, they are more likely to buy that cookie when they are at the counter, resulting in more money for the business.
Implementing an effective way to receive upfront payments does not necessarily have to cost a lot or cause a massive upheaval in business operations. For Saas companies it is ingrained in their operations, and for Starbucks, the benefits received far outweigh the cost of developing and upkeeping an app. Simply, if executed properly, the ROI for implementing a way to receive upfront payments is huge.
Cash is king. And when a business is cash rich, they can afford to stand out in numerous ways.