One of the best ways to raise short-term working capital is to take deposits from customers. However, not all industries use this type of finance. Customer deposits are commonly found in industries that require a big outlay of cash to the seller, before a sale can be concluded, for example the event management industry. Sometimes this occurs if the product that is being sold has a limited resale value. The seller asks for a deposit in case the deal falls through. In other words, it provides the seller with a safety net.
The issue of asking for a deposit can be a sensitive one. It has to be considered carefully before you adopt it as a business practice. Use standard practices in your specific industry as a benchmark – see what your competitors are doing. If they’re asking for deposits, maybe you should too!
How customer deposits work
Your business (if it uses customer deposits) can request a range of deposit requirements from your customers.
At one extreme, clients can be required by a business to pay the full amount upfront before the business delivers their side of the sale. This is generally used selectively in order to focus the business on a certain market. For example, a surfboard manufacturer may decide to start focusing on corporate clients. He won’t charge upfront payments (and perhaps won't charge deposits at all) to these corporate clients, but rather than simply turning away his small, individual, existing clients, he may charge them full upfront payment. If they accept, their business is still worth his while. If they don’t, he gets to focus more on his corporate market. Another example is the event management industry where many service providers require a 50% deposit before they will begin work; music festivals are run the same way.
The cost of customer deposits
There are no direct costs to you when using customer deposits as a means of financing the work required to enable final delivery to the customer. However, you do need to be aware that the deposit belongs to your customer until such time as you have supplied the associated product or service. This means you are legally bound to refund any monies they gave you in the event that you do not supply the goods.
An exception to this is the property industry. In this case customer deposits on the property the tenant is renting may not be used to finance your operations. The deposit must be kept in a separate interest bearing account and refunded, together with interest, on conclusion of the lease agreement.