- Many companies are demanding proforma payment terms as they attempt to trade out of the pandemic
- Proforma payment means requesting payment upfront via a proforma invoice before goods and services are delivered
- However, proforma trading can restrict growth just when it is most needed
The pandemic has changed a lot of business practices, one of which is a rise in proforma trading. But although this may seem to make a business safer, in reality it can make trading riskier — and reduce growth.
What is proforma trading?
Proforma trading is where a business demands payment before supplying goods or services. Typically, a company will issue a proforma invoice to the customer. Once this is paid, the goods or services will be delivered.
As UK businesses trade out of the pandemic, it may seem a logical way for a company to protect itself. Andy Imrie, Regional Commercial Manager North & Ireland at Euler Hermes UK, says: "The pandemic has exaggerated the need for a lot of suppliers to be ultra-conservative on how much credit they extend.”
However, Imrie and his Euler Hermes colleague Darren Felsenstein, a credit insurance consultant, have identified three problems with asking for proforma terms.
1. Proforma trading can reduce growth
Proforma trading can choke the natural growth in customer accounts. Your customers may be comfortable with proforma payment for their first £5,000 order — indeed, many businesses insisted on cash terms for new customers even before the pandemic. But, from your customer’s point of view, sending £20,000 for a follow-up order in today’s environment feels risky, so order volumes never increase.
Just as you are nervous about their non-payment, your customers are anxious about your non-delivery.
Andy Imrie comments: "There is often a natural crossroads where the supplier has to decide whether they want to grow this customer relationship further. And one of the ways they can do that is by making it easier to get service from me than another company down the road."
2. You may lose customers altogether
Although many firms are cash-rich, they will still migrate to suppliers who can offer conventional credit terms. Darren Felsenstein says: "In this climate, if your customers find someone doing the same job as you, who offers them business on credit terms, they will move."
In October, the Bank of England noted that many SMEs are in debt for the first time after taking government support and may struggle to repay. These companies will need to deploy their cash to trade their way out of trouble. They won’t want to deploy it into their suppliers’ bank accounts.
3. Proforma terms send a negative signal to customers
Andy Imrie notes that companies are constantly checking their business partners for signs of stress in this environment. What kind of message does it send if your firm demands proforma payment? Does it signal that your firm is running low on working capital?
“If I need your money before I can do anything, it makes it look as though there is a chance that delivery may never happen,” he says.
Moving back to business as usual
Business trading on credit has a very long history - agricultural trade was conducted on credit in ancient Babylon more than 3,500 years ago - and there was a good reason for its invention. Andy Imrie says credit "keeps the cogs turning" in business, creating flexibility and liquidity.
"If you artificially stop that by demanding proforma terms, then that will cause the economy to slow in some areas," he says.
Business owners have a more pressing concern than the whole economy: protecting their firm. After all, this is a treacherous business environment. There is a "credit risk iceberg", where even long-standing customers may have problems hidden below the surface. There is the “insolvency domino effect” to worry about. And as government support tapers off, there are fears of a rise in insolvencies.
Darren Felsenstein says the increased use of the proforma invoice is driven by a lack of information: “Companies that use proforma tell me they do so because they don’t know much about their customer behind the scenes.”
Informed decisions on risk
But companies offering trade credit insurance have both public and private information about businesses. They also have broader knowledge that can inform decisions on risk, such as market intelligence on payment and cash flow in particular sectors.
Andy Imrie says: "We take some of the pressure off the business owner, so they don't have to stick a finger in the air and make the decision entirely themselves."
He adds that companies using trade credit insurance to control possible customer default shouldn't entirely ignore customer risk. However, it does allow a return to pre-pandemic flexibility and convenience in trading — and can avoid the three major drawbacks.
This extends to overseas customers. Darren Felsenstein says that with Euler Hermes’ strong international network, companies can have the confidence to offer credit for export orders too.
“What we’re trying to do,” he says, “is give companies every opportunity to grow.”