Effectively Managing Credit Risk
Offering credit terms to customers can be a slippery slope if not managed correctly. Large white- collar companies refuse to do business without a credit line and extended payment terms, some up to 90 days. Many of these big companies usually do pay their accounts within the boundaries of the credit agreements.
Small to Medium Entities (SME’s) face a bigger risk and extreme care is required when credit is requested or when offering to build customer relationships. Today we discuss these risks and measures below.
Existing customer history
When looking at extending credit, start by looking at the customer’s history with your company. A company who has been a loyal cash customer for 6 months or longer, shows that they will be a loyal customer in the future. You have built a relationship of trust and thus taking the step to offer credit is a natural evolution of the business relationship. Building such a history is not always possible, but it lays the foundation for healthy credit accounts. It ensures that you know your customers business and payment patterns.
Many companies have situations where a new customer immediately require credit. In order to secure the business deal, credit is approved, stock is delivered, and the company disappears with the stock, without paying. This is not an uncommon scenario. When a new customer requires immediate credit, it may be for various reasons. It may indicate problems with cash flow which may influence how they manage their account payments. It can also be due to a growth period in the business where cash flow is restricted, but the overall health of the company is acceptable. Doing in depth credit checks are non-negotiable, especially where a business has been operating for a year or less. Not only will it show judgements and defaults, but it will also present an up-to-date snapshot of the company’s assets compared to their debt burden. One of the most important checks are the credit checks done by other companies within the past month. Compare this to the Financial Statements and you will get a clear picture of either a healthy, growing business or one that is over indebted and will not be able to pay their debts.
Approving credit for your customers cannot be a “one size fits all” approach. Each company’s request for credit should be evaluated by doing an in-depth credit check, looking at the relationship built to analyze credit requirements and how their debtors’ influence their liquidity to maintain a healthy credit account. A customer who has dealings with the government, may face ate payments on a regularizes. This may influence their ability to pay you on time. In cases like these, credit terms can be extended to allow for these fluctuations. However, this needs to be carefully monitored so as not to create an unacceptable risk profile. The most commonly accepted credit terms are 30 days from date of statement. Credit limits of 7 to 14 days are becoming more popular with smaller businesses who only need a small delay in payment to ensure constant and healthy cash flow. A seasoned debtors’ clerk will know exactly what to look for in order to make informed and low risk credit recommendations.
Managing customer credit limits are imperative to ensure minimum risk to your business. The best way to manage credit is to ensure payments are received at due date. When a customer misses a payment date, payment needs to be followed up within one day. If payment is not confirmed to be received on day one of missing a payment, the account should immediately be placed on stop supply. The customer and other role-players should immediately be informed about this in order to manage any problems which may arise from this action. Payment may not be withheld due to queries on an account. Customers have a full month between receiving their statement and having to make payment. In that period, all queries should be followed up and if not resolved, only the payment relating to the query may be withheld. Being strict in maintaining credit limits and agreements ensures that customers are aware of the standard of credit management set you and will rarely miss a payment unless there is a good reason. Most customers will soon learn to discuss possible late payments timeously to avoid the risk of interruption of supply.
Businesses aren’t stagnant and their financial and operation situations will fluctuate from time to time. It is thus extremely important to do an annual credit review of each customer to determine if the current credit facility and terms are sufficient, necessary, and required. In doing these reviews, updated financial statements and credit checks are done and changes in the customer’s requirements can be identified and discussed in order to offer a bespoke service to them. Dormant customers can be identified with information being made available to your sales team for follow up. Credit limits dormant for one year and longer, should be cleared and terms reset to COD. If the customer returns, a new credit application must be processed to analyze updated financial information.
Offering credit terms and limits can be a great tool to grow business and build relationships. However, it exposes your company to increased risk which could lead to bad debt and cash flow restrictions. Spreading the risk between large, white-collar customers and SME’s is crucial and keeping your finger on the pulse of your customers’ performance should form part of your day-to-day duties. It is impossible to run a business without extending credit, but it is possible to successfully manage the risk to protect and grow your business by applying the basic principles as discussed above.
Contact us to find out more about how our Debtors Consultants can help improve your cash, recover your money, and make it easier for you to prosper.