One of the best ways to raise short-term working capital is to take deposits from customers.
Is your business the right fit?
Certain industry sectors regularly use customer deposits as a means of funding working capital. A good example is the music and entertainment sector. If you contract an artist to perform at a concert, it is standard practice for 50% of the performance fee to be paid upfront when the contract is signed.
Customer deposits are commonly found in other industries where the cost of providing the service or the product is large. Sometimes this happens also when the product that is being sold has a limited resale value. The seller then asks for a deposit in case the deal falls through. In other words, it provides the seller with a safety-net.
Deposits - good idea or bad idea?
It’s true, asking for a deposit can put some customers off – and they may prefer to go with another service provider who doesn’t require a deposit.
It is up to you to find out whether your industry sector finds customer deposits acceptable and to know your clients well enough to gauge their reaction should you decide to introduce customer deposits.
The issue of asking for a deposit can be a sensitive one and should be considered quite carefully before you adopt it as a business practice. The most important thing is to be able to explain to the customer why this is necessary.
Size of customer deposits
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 bargain. This is usually 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, whom he certainly won’t charge upfront payments and perhaps won't charge deposits at all. But rather than simply turning away his small, individual, legacy clients, he may charge them full upfront payment. If they accept, their business is still worth his while. If they don’t, he gets more time to focus more on his corporate market. Another example is international suppliers who expect to be paid before they ship the product.
At the other end of the spectrum is companies that ask only for a 25% deposit which is often positioned as a commitment fee. Other companies set up a series of payments for the duration of the contract. So, you would need to decide what deposit amount is most suitable for your industry and your company. Bear in mind that if you ever intend to raise finance using debtor finance (invoice discounting), many lenders are not to keen to finance invoices with split payments.