Money collected before delivery is not earnings and not capital. It is a liability that becomes a cash call at the worst possible moment.
Somewhere in your organisation this month, a commercial manager will halve a deposit to win a deal, or double a distributor's credit period to secure a volume commitment. Neither decision will reach the board. Neither will be recorded as a change to the enterprise's funding structure. Both are exactly that.
Businesses that collect from customers before they pay suppliers operate on other people's money. The float this produces is real, cheap and — for the right model — a genuine structural advantage. It funds inventory and expansion without negotiating with a lender for the privilege, and executives who have built one rightly regard it as a competitive asset rather than an accounting curiosity.
The difficulty is what happens on the way down. The float is generated by growth in forward commitments rather than by accumulated profit, so it contracts when commitments contract. The obligations it represents do not. That asymmetry is where customer-funded businesses fail, and it is almost never modelled at the point the terms are set.
The Strategic Context
Working capital is usually treated as a finance concern — a ratio to be optimised, a cycle to be shortened. In a customer-funded model it is the enterprise's primary source of capital, with its terms negotiated by people whose incentives are measured in volume rather than liquidity.
The mechanics are simple. Take money from customers, partners, franchisees or distributors before you incur the cost of serving them, and pay suppliers after. If the gap is wide enough and volume high enough, the business carries a permanent pool of cash it did not earn and does not own. On any given day the pool looks like a bank balance. Structurally it is a set of promises to deliver.
This is the third funding source, alongside borrowing and selling ownership, and materially cheaper than both — no interest, no covenant, no dilution, no board seat. It is also the only one that arrives without anybody deciding to raise capital, which is why it is the least likely to be governed. It depends on two external conditions: customers accepting the timing, and suppliers accepting the reverse timing. Both can change without notice.
The Balance That Is Not Yours
The first misreading treats the bank balance as a measure of health. A business collecting advances holds cash through periods of poor trading, and that cash gets read as evidence the trading is not so poor. It is evidence of nothing except the size of the delivery obligation — a close relative of the wider habit of reading early cash as proof of a working model [Related article: Cash Arrives Fast. Is That Profitability, or Only That You Have Not Found Out?].
The second treats the float as permanent capital. It behaves that way while volume is stable or rising, which can be long enough for the organisation to build a cost base on top of it. It is not permanent. It is the visible balance of a flow that reverses.
The third assumes it is free. Something was given up to obtain it — a discount, a longer warranty, a favourable termination right. Expressed as an annualised rate on the money advanced, that concession is the true cost of this capital. Few organisations calculate it, and some are paying more for customer money than a lender would have charged while congratulating themselves on avoiding debt. The fourth misreading holds that because no lender is involved, nobody can call the money back. Customers can, and the contract usually says so.
Reframing the Issue
Stop thinking of advances as revenue timing. Think of them as unsecured borrowing from a very large number of counterparties, each with a right to be repaid in cash or in delivered goods, none of whom will negotiate a standstill.
The question then changes. It is no longer how much cash we hold. It is: if volume fell by a third and stayed there two quarters, what would we owe, to whom, in what form, and on what date? A business that cannot answer that in a morning does not know its own funding structure.
Where the Float Comes From and What It Is Made Of
The sources look different and behave alike. Customer deposits and progress payments. Subscriptions and retainers billed ahead of the service period. Franchise or partner entry fees and the security bonds behind them. Distributor prepayments taken in exchange for a better price. Extended supplier terms, the same trick performed on the other side of the ledger. Unredeemed credits and loyalty balances.
What matters is not the label but four properties: whether the money is refundable and on what trigger; whether the obligation it funds has already been incurred as committed cost; how long the delivery lead time is relative to the cancellation window; and whether the counterparty's solvency is correlated with your trading conditions.
That last one is most often ignored. If your advances come from partners whose businesses depend on the same end market you do, their distress and your revenue decline are the same event, and you will be asked to refund money at the moment your own receipts have stopped. A supposedly diversified funding base can be a single exposure wearing many names.
The Unwind: Why the Liability Calls When Volume Falls
Three mechanisms fire at once when volume declines, and they compound.
New advances stop. The float is a function of the rate of new commitments, so a fall in orders removes the inflow immediately, well before it shows in reported revenue.
Delivery obligations continue. You must still serve the customers who paid last quarter, incurring labour, materials and freight with no matching receipt. The cost of honouring old advances lands in the same period the new ones disappear.
Refund and cancellation rights crystallise. Customers who sense difficulty exercise the rights they hold; partners who cannot trade ask for their bonds. A stable balance becomes a queue of claims, forming faster than the trading deteriorates because it is driven by expectation rather than results.
Consider a hypothetical illustration, offered to show the shape of the problem rather than as any observed case. An enterprise holds advances equal to roughly a quarter of annual sales and has committed that cash to fixed obligations — a larger facility, a permanent workforce, an equipment finance schedule. Orders fall by a third and new advances fall with them, while the delivery obligation from prior advances persists at full cost. If even a modest share of remaining advance holders cancel, the business faces an outflow in a quarter when inflow has fallen and fixed costs have not moved. Nothing there requires a crisis — only an ordinary cyclical decline meeting a funding structure nobody classified as funding.
Each mechanism alone is manageable. Together they invert the cash profile of the business in a single quarter.
The Discipline That Makes It Survivable
The float is safe when it funds the working capital cycle it came from and unsafe when it funds fixed commitments. That is the whole of the discipline, and it is unpopular because the second use is where the growth is.
Money taken from customers is available to buy the materials, pay the wages and fund the inventory required to deliver what those customers bought. Used that way it is self-liquidating: obligation and asset extinguish together. The moment it signs a long lease, hires a permanent team or services an equipment finance agreement, a reversible liability has become an irreversible commitment.
A workable policy states in advance what proportion of the float may fund anything beyond the cycle that generated it, and a defensible answer in many businesses is none. It sets the unencumbered liquidity held against the refundable portion. Calibrating any of it requires knowing the volume at which the fixed cost base stops being covered at all [Related article: The Number Below Which the Enterprise Is Structurally Loss-Making].
The legal position matters and varies. Australian requirements on consumer prepayments, when advances must be held on trust, disclosure obligations, and the ranking of customer claims where a business fails all require verification with qualified legal advisers before any policy is adopted [FACT CHECK REQUIRED]. ERANORTH is not a law firm or a financial adviser, and none of this is legal or financial advice.
Who Actually Sets the Terms
Deposit percentages, credit periods, refund triggers and entry fees are set inside commercial negotiations by people accountable for winning work, with no requirement to consult anyone accountable for liquidity. Each concession is small and defensible. In aggregate they rewrite the capital structure within a year or two, and no document records it.
Contrast the alternatives. Borrowing requires a credit paper, a covenant package and usually a board resolution. Selling ownership requires a valuation, a shareholders' agreement and a decision about who now has a say, and the price is at least visible in the negotiation [Related article: Fund the Bet in a Vehicle of Its Own]. Customer funding requires a signature from a regional sales manager.
Three controls close the gap without slowing anything down. Terms outside a defined envelope require finance sign-off. The float is reported to the board monthly, split by refundability and delivery lead time rather than as a single cash figure. And the sales incentive scheme recognises payment terms, so a deal won on worse terms is not rewarded as the same deal.
Decision Framework
Assess each source of advance separately rather than treating the float as one number.
| Source of advance | What triggers repayment | Correlated with a downturn? | Safe use |
|---|---|---|---|
| Deposits on made-to-order work | Cancellation before delivery | Strongly — cancellations rise as demand falls | Committed materials and labour only |
| Subscriptions and retainers billed ahead | Termination rights, service failure | Moderately — churn rises with customer stress | The service period it covers |
| Partner or franchise entry fees | Partner exit, non-performance, dispute | Strongly — partner distress tracks yours | Refundable until obligations discharged |
| Refundable security bonds | Contract end or breach | Strongly | Hold matched liquidity; never deploy |
| Extended supplier terms | Supplier tightening, insurer withdrawal | Strongly — suppliers tighten as your sector weakens | Treat as a facility withdrawable without notice |
Four questions then determine whether the model is sound. What proportion of the float is contractually refundable within ninety days? What proportion of fixed monthly commitments is funded by float rather than margin? What implicit rate are we paying, expressed as the annualised value of the concessions that obtained the advances? And if our three largest advance-paying counterparties all sought refunds in one quarter, what would we do that Monday?
From Strategy to Execution
The immediate work is measurement and authority. Produce one schedule of every category of money held before delivery, showing amount, refund trigger, notice period and remaining delivery obligation. Most organisations find the total larger than assumed and several categories without an owner. Then set the authority threshold for changing payment terms, and communicate it as a financial control rather than a commercial constraint.
The medium-term work is contract design and stress testing. Terms can be engineered for resilience: milestone payments that match cash to committed cost, refund windows shorter than production lead times, staged partner fees tied to obligations discharged. Then run the volume decline scenario as a cash sequence month by month, with the delivery obligation running to its natural end, rather than as a revenue sensitivity.
The long-term question is whether the model should be defended or reduced. A durable customer-funded structure rests on a real reason customers pay early — scarcity, specification, genuine service value, an industry norm. If the only reason is a price concession, the structure is rented rather than owned, and a competitor takes it by conceding slightly more. Which of those you have is a judgement about the source of your pricing power.
Signals to Monitor
Track the float as a proportion of forward order value rather than in absolute dollars, because the absolute figure hides the direction of travel. Watch the average deposit percentage across new contracts as a leading indicator of competitive pressure; it usually falls quietly for two or three quarters before appearing anywhere else.
Watch refunds and cancellations as a rate rather than a count, and the ratio of unencumbered cash to refundable advances. Watch supplier behaviour — a shortening of your terms is often the earliest signal that sector credit conditions have turned, and it removes half the float mechanism at a stroke. Watch for credit insurers withdrawing cover. And watch how far the fixed cost base has grown since the float began funding it, which measures how much of the reversible has become irreversible.
Questions for the Leadership Team
- How much of the cash on our balance sheet is money we would have to return or deliver against, and who calculated that figure?
- Who is authorised to change customer payment terms, and how many people exercised that authority last year?
- What did we give up to obtain our advances, and what annualised rate does that represent against our cost of borrowing?
- Which fixed commitments are funded by float, and what is our plan for them if the float halves?
- Is there a reason our customers pay early that survives a competitor offering better terms?
Closing Perspective
A customer-funded model is a genuine advantage and should be built deliberately by organisations whose economics support it. But it carries a specific and knowable failure mode, and that failure mode is not gradual. It arrives as a step change in a single quarter, triggered by an ordinary decline in demand rather than anything dramatic.
The decisive question is not whether customers can fund the business; in many industries they plainly can. It is whether the enterprise has decided, at board level, what that money is permitted to do. Money funding the cycle it came from is capital the business has earned the use of. Money funding the fixed cost base is a debt that will be called by counterparties who never thought of themselves as lenders, at the moment the business is least able to pay.
Most organisations running this model have made that decision. Very few made it on purpose.
About the author
Kevin Jogin is Founder & Principal Advisor at EraNorth. Meet the Founder.