The dangers of pre-payments

We have recently dealt with the liquidation of a company whose business model relied on customers pre-paying for the goods in advance. The circumstances highlight the dangers when trading becomes challenging; even where there is a very attractive business model.

The customers were generally small and medium-sized businesses and the general public. The company advertised via online portals and customers were obliged to make payment in full with their order. The company held no stock and purchased from larger suppliers; with delivery arranged directly from the supplier to the customer.

As a business model, this should work brilliantly; the business requires little funding, is cash positive, has no need for substantial premises, staff and other overheads, and has the certainty of margins. Where things started to go wrong was gearing up to deal with rapid growth, issues with suppliers, issues with hauliers, goods delivered but not as specified, increased competition, pressure on margins, not dealing with accounting issues on time; seasonality, failure to control overheads etc.

Many businesses operate successfully on this, and similar, business models and much internet retail business is done on this basis; albeit with the support of banks and credit card companies. The usual ‘warning signs’ however remain. Why is our bank balance less/worse than it should be? Why are we on ‘stop’ with this haulier? Have we the funds to pay this VAT bill in full? Is our financial information reliable and up to date? Do we need some additional funding? Shall we make an injection of personal funds or approach the bank? What’s the risk to those funds?

Even with the best business models, things can go awry. In the event that these familiar warning signs appear, directors should consider discussing such concerns with us and hence avoid the sort of allegations that were made in this case by unhappy customers. To discuss further, please contact us here.