How are you avoiding the high cost of receivables?
We know that choosing a pricing model for your firm not only dictates how you arrive at your fees but also when clients will pay you.
Any model that forces you to delay billing until work is completed also forces your firm to cover all costs and expenses–your payables—while waiting for clients to pay.
Your payables include payroll, utilities, insurance, leasing or mortgage, and so on.
When you delay billing until completion or after specific milestones are met, you also then wait 30, 60 or 90 days to get paid.
Not how much but how soon?
My conversations with Owners and Executives of professional and business services firms always focus on how much should we charge?
The more important question is when is payment required (payment terms)?
Put yourself in the shoes of the Founder whose firm bills about $1 million in revenue per year.
The firm bills by the hour (their pricing model). Therefore they invoice once per month. The payment terms are 30 days from date of invoice.
Even if the invoices are sent within a day or two of the end of the month, and the client pays quickly, the firm waits at least 35 days from time of completion to receipt of payment.
We all know from experience that most buyers pay on or just before the due date.
For example, work done on Feb. 1-2, is billed on Feb. 28, and is paid for on March 28.
Let’s say that the firm has an unsecured line of credit to help with payables while waiting for receivables.
While this is a simplified example the point is clear.
Let’s say that in the course of the year, the firm bills $1 million.
Therefore its annual average account receivables is $1 million.
Cost of receivables
All work is billed in arrears, meaning that all $1 million dollars in revenue (sales) spends time in accounts receivable.
To understand the impact and cost of receivables, you have to use a specific time frame. For ease of explanation here I am using yearly.
The firm borrows from its line of credit to pay its own payables. Thus it is borrowing $1 million every year. The cycle is borrow, repay, borrow, repay, borrow, repay, all year long.
Now let’s look at the cost of that borrowing.
Typically lines of credit are priced at Prime+4.5 to 6.5%.
On Feb. 2, 2023, the Wall Street Journal’s Money Rates Table reported that the prime rate is 7.75%.
So in the best case, using a line of credit costs the borrower 7.75+4.5=12.25%
On $1 million, that’s $125,000 in interest costs per year.
What could your firm do with $125,000?
- Increase payroll either to current employees or by hiring additional employees
- Purchase an income generating asset to grow the firm
- Upgrade technology to provide better customer service.
- Invest in client cultivation with more access, judicious use of thank you gifts, and more efforts to gain referrals.
- Expand into a new line of services or into a new market.
- What else?
What is the alternative to $125,000 in interest costs?
Without a doubt, the single best pricing model for your professional or business services firms is one that allows you to require payment before you begin the work to deliver life changing differences to clients.
Two models are 1) fixed fee and 2) pricing commensurate with the life changing differences delivered, or what I call IMPACT Based Pricing.
Fixed fees are useful for IMPACTs that derive from fairly predictable and repeatable inputs. You must always require payment upon signing a contract or purchase agreement. No work begins until payment is received.
IMPACT Based Pricing allows huge flexibility and customization to deliver life changing differences according to the clients needs, wants, and desires. Use our Issue Chart and Continuum of IMPACT to find out what your clients are thinking.
Every offer or proposal must include a start and end date, well designed scope, and payment in advance.
If your professional services firm deliver impacts every month, your proposal or offer must require payment on the first of the month.
Once you have IMPACT Based Pricing in place, you can start thinking about how you’re going to spend your $125,000!