Somewhere in a business this month, a salesperson will halve a deposit to win an order, or a manager will extend a large customer’s payment terms to secure more volume. Neither decision is likely to reach the owner or the board as a funding decision. Both are exactly that.
Businesses that collect money from customers before they pay their suppliers operate partly on other people’s money. Deposits on custom orders, subscriptions paid in advance, retainers, prepaid services and long supplier terms can together create a pool of cash the business holds but has not yet earned. This float is real, cheap and, for the right business, a genuine advantage. It can fund materials, stock and growth without a bank loan or new investors.
The difficulty comes when orders fall. The float is created by the flow of new commitments, so it shrinks when commitments shrink. The obligations it represents, to deliver what customers have paid for, do not. This article explains how customer funding works, what the float is really made of, why it can turn into a sudden cash call when volume falls, and the simple disciplines that let a business enjoy the benefits without the danger.
How customer funding works
The mechanics are simple. Take money from customers before incurring the cost of serving them, and pay suppliers after. If the gap is wide enough and volume steady enough, the business carries a pool of cash it did not earn and does not own. On any given day, the pool looks like money in the bank. In substance, it is a set of promises to deliver.
Common sources include:
- Deposits and progress payments on made-to-order work.
- Subscriptions, memberships and retainers billed in advance.
- Prepaid services, gift cards and credits not yet used.
- Entry fees or bonds paid by partners, licensees or franchisees.
- Prepayments by distributors in exchange for better prices.
- Long credit terms from suppliers, which perform the same trick on the other side.
Customer funding is a third source of finance alongside borrowing and selling ownership, and it is often cheaper than both: no interest, no covenants, no dilution. It is also the only one that arrives without anyone deciding to raise money, which is why it is the least likely to be managed deliberately.
Common misreadings
- The bank balance shows the business is healthy. A business holding customer deposits can have plenty of cash through a period of poor trading. That cash shows the size of its delivery obligations, not the strength of its trading.
- The float is permanent capital. It behaves like permanent capital while volume is stable or growing, often long enough for the business to build costs on top of it. It is not. It is the visible balance of a flow that can reverse.
- It is free. Something was usually given up to obtain it: a discount, extra warranty, flexible cancellation. Expressed as an annual rate, that concession is the true cost of the money.
- Nobody can demand it back. Customers can, through cancellations, refunds and the right to receive what they paid for.
What the float costs
Concessions made to obtain early payment have a cost that can be compared with borrowing. For example, offering a 3% discount for payment 60 days earlier than usual is roughly equivalent to paying about 19% a year for the use of that money, calculated as 3 ÷ 97 × 365 ÷ 60. Some businesses pay more for customer money than a bank would charge, while congratulating themselves on avoiding debt. Work out what your concessions cost before treating customer funding as free.
Four properties of each source
The label on each source matters less than four properties:
- Is it refundable, and on what trigger? Cancellation, termination, dissatisfaction or failure to deliver.
- Has the cost of serving it already been committed? Materials ordered, work in progress, staff hired.
- How long is the delivery lead time compared with the cancellation window? A long lead time with an easy cancellation right is a risk.
- Is the counterparty’s health linked to your market? If your deposits come from customers or partners who depend on the same conditions as you, their distress and your falling sales are the same event, and refund demands will arrive just as your own income drops.
What happens when volume falls
Three things happen at once when orders decline, and they compound:
- New advances stop. The float depends on the rate of new orders, so a fall in orders removes the inflow immediately, well before it shows in reported revenue.
- Delivery obligations continue. The business must still deliver to customers who paid last month or last quarter, paying for materials, labour and freight without matching new receipts.
- Refunds and cancellations increase. Customers who sense difficulty exercise their rights. Partners ask for their bonds back. A stable balance turns into a queue of claims.
Each alone is manageable. Together they can turn the cash position of a business around in a single quarter, triggered by an ordinary slowdown rather than a crisis.
The discipline that makes it safe
The essential rule is simple: customer money is safe when it funds the work it came from, and risky when it funds fixed commitments.
Money taken from customers can safely buy the materials, pay the wages and fund the work needed to deliver what those customers bought. Used that way, the obligation and the asset extinguish together. The moment it pays for a long lease, a permanent increase in staff, new equipment or a fit-out, a reversible obligation has been turned into an irreversible commitment.
A sound policy states in advance how much of the float, if any, may fund anything beyond the work that generated it. For many businesses, the safest answer is none. It also sets a level of unencumbered cash to be held against the refundable portion of customer money.
Who sets the terms
Deposit levels, credit periods, refund conditions and partner fees are usually set in sales negotiations by people measured on winning work, not on cash. Each concession is small and reasonable. Together they can change the business’s funding structure within a year or two without anyone recording it.
Three simple controls help:
- Terms outside an agreed range need finance or owner sign-off.
- The float is reported monthly, split by how refundable it is and how long until delivery, not as one cash figure.
- Sales incentives reflect payment terms, so an order won on weaker terms is not rewarded as if it were the same.
Design terms for resilience
Payment terms can be designed to reduce the risk without giving up the benefit. Useful approaches include:
- Milestone payments that match committed cost, so customer money arrives as the business commits materials and labour to the order, rather than as one large upfront amount that may be spent elsewhere.
- Cancellation windows shorter than production lead times, so cancellations happen before significant cost is committed.
- Clear cancellation terms that allow the business to retain amounts covering costs already committed, where the law permits.
- Staged partner or licence fees tied to obligations the business has met.
- Separate tracking of customer money in the accounts, so its size and use are visible.
Take legal advice before changing customer terms, particularly for consumers, because the Australian Consumer Law limits unfair contract terms and protects consumer rights to refunds in some situations.
Assess each source separately
| Source | What triggers repayment | Linked to a downturn? | Safe use |
|---|---|---|---|
| Deposits on made-to-order work | Cancellation before delivery | Often strongly | Materials and labour for those orders |
| Subscriptions and retainers in advance | Termination, service failure | Moderately | Delivering the service period paid for |
| Partner or licence entry fees | Exit, non-performance, dispute | Often strongly | Hold until obligations are met |
| Refundable bonds | End of contract or breach | Strongly | Hold matching cash; do not spend |
| Long supplier terms | Supplier tightening terms | Often strongly | Treat as a facility that can be withdrawn |
A worked example
This is an illustration. A custom furniture maker takes 50% deposits on orders with a ten-week lead time. Orders run at about $200,000 a month, so about $100,000 of deposits arrive each month. With roughly two and a half months of orders in progress at any time, the business holds about $250,000 of customer deposits.
Over the past year, the owner used about $150,000 of that cash to fit out a new showroom and signed a five-year lease. The bank balance still looks comfortable at about $130,000 after normal trading.
Then orders fall by a third, to about $133,000 a month. New deposits fall to about $67,000 a month. As earlier orders are delivered, the deposits held shrink towards about $167,000, two and a half months of the lower deposit rate. That is about $83,000 of cash leaving the business over the next couple of months, on top of normal trading, simply because the float is shrinking. Around 10% of customers with open orders, nervous about the slowdown, cancel and are refunded about $25,000.
Together, about $108,000 drains away, leaving roughly $22,000 in the bank before any trading losses, while the showroom lease and fit-out loan continue. The business is not unprofitable. It has used customer money to fund a fixed commitment, and that money has been called back.
The owner responds by negotiating with the landlord, reducing fixed costs, moving to staged payments on large orders and adopting a policy: deposits fund only materials and labour for the orders they came from, and a minimum cash balance equal to half the refundable deposits is held at all times. Future fit-outs will be funded from profit or appropriate finance.
How this applies to a small Australian business
Many small businesses take deposits or prepayments: builders, furniture makers, event businesses, training providers, subscription services and custom manufacturers. Practical steps:
- List all money held before delivery, with amounts, refund conditions and delivery dates.
- Calculate the cost of concessions made to obtain early payment.
- Keep customer money for the work it came from.
- Hold unencumbered cash against refundable amounts.
- Stress-test a fall in orders month by month, including continued delivery costs and some cancellations.
- Set sign-off rules for payment terms outside an agreed range.
- Check your legal obligations: under the Australian Consumer Law, customers may be entitled to refunds if a business cannot supply what they paid for, and some industries, such as domestic building, have specific rules on deposits. Check current requirements with the relevant regulator or a legal adviser.
The articles on cost reports and cash flow and what the balance sheet says about cash, stock and customers who owe you cover related ideas.
Signals worth watching
- The float shrinking as a share of forward orders.
- Average deposit percentages falling on new contracts.
- Rising cancellations and refund requests.
- Suppliers shortening their terms.
- Credit insurers reducing cover in your sector.
- Fixed costs that have grown since the float began funding them.
- A comfortable bank balance alongside weak trading.
Common mistakes
- Treating deposits as profit or as permanent capital.
- Funding fixed commitments with customer money.
- Ignoring the cost of concessions that obtain early payment.
- Letting sales set payment terms with no check on cash.
- Reporting the float as one number rather than by source and refundability.
- Never stress-testing a fall in orders.
Frequently asked questions
Should we stop taking deposits? No. Deposits are valuable and often appropriate. The aim is to use them for the work they relate to and plan for the day they shrink.
How much cash should we hold against deposits? It depends on how refundable they are, how long until delivery and how stable demand is. Holding unencumbered cash equal to a meaningful share of refundable deposits is a sensible starting point. Discuss it with your accountant.
What if we have already used deposits to fund fixed costs? Measure the exposure, build a cash forecast for a fall in orders, and reduce the risk over time by rebuilding cash, refinancing the fixed commitment appropriately or reducing fixed costs.
How do we explain a deposit policy to customers? Simply and honestly: deposits secure their place in the schedule and fund the materials for their order. Customers generally accept deposits when they are proportionate and when the business delivers reliably.
Do supplier terms count? Yes. Long supplier terms are part of the same float, and suppliers can shorten them quickly when conditions tighten.
Questions to ask
- How much of our cash would we have to refund or deliver against, and who calculated it?
- Who can change customer payment terms, and how often did they do so last year?
- What did we give up to obtain early payments, and what annual rate does that represent?
- Which fixed commitments are funded by customer money?
- What would happen to our cash if orders fell by a third for six months?
- Is there a reason our customers pay early that would survive a competitor offering better terms?
Bringing it together
Customer funding is a genuine advantage, but it is a promise, not profit. Money funding the work it came from is capital the business has earned the use of. Money funding fixed costs is a debt that will be called back by people who never thought of themselves as lenders, at the moment the business is least able to pay. Know what your float is made of, price the concessions behind it, keep it for the work it came from, hold cash against refunds and test what happens when orders fall.
Source: KEVOS notes. Examples and figures in this article are illustrations. This article is general information, not financial or legal advice.
