16 Nov Are your debtors dragging you down?
The December-January period can be a cash boom for some businesses, but it can be a cash drain for others. Many will close their doors for a much-needed holidays break. But closed doors mean no cash coming in, and plenty still going out to cover permanent wages and overheads.
So, if you’re starting to think about how you are going to get through your planned Christmas closure, it might be time to start thinking about your receivables.
Not managed well, receivables – ie. money your business is owed – can become a major issue for businesses. The most effective way to manage receivables is to put into place a system that allows management to:
- Provide credit to eligible customers only
- Keep track of receivables in a timely manner
- Trigger follow-up calls/emails/letters for reminders/past due/legal action, and
- trigger when management intervention or legal recourse becomes the next action.
This allows for the majority of receivables to be managed in an orderly and efficient manner, while allowing problem accounts to surface immediately.
Providing credit is a cash flow-draining strategy for any business and should therefore be seen as a privilege provided to customers. However, a business may be able to expand revenue very quickly by extending lines of credit to customers that would have otherwise not been able to pay for items.
Providing credit then becomes a risk-based decision for your business and you should be aware that the risk may be passed on to external agencies such as credit card companies and financing institutions.
By making the upfront payment experience as painless as possible, applying for credit becomes less attractive. Ensure you credit card facilities, debit card purchase, EFTPOS or PayPal as payment options. Extending credit then becomes an option that your business provides as a special case.
To formalise this, assume that all customers who request credit terms must first fill out a credit application form.
Creating a credit judgement criteria checklist
Once your business receives a credit application, a system must be put in place to allow for an evaluation of the potential customer’s ability to pay on credit terms. Your business should therefore create a credit judgment criteria.
A crucial feature of the credit application form is the inclusion of references. It’s important to follow up each with a phone call to the referee. A lot of credit checking systems fail due to human error when credit referees are not followed up. Make sure this is part of the system and is adhered to by completing a credit judgment criteria checklist.
Advertising credit terms
If your business is putting itself in a position to shoulder the cost of providing credit, then you should think carefully about using credit terms as an advertising or marketing tool. Doing so may have the negative effect of draining cash reserves. You should only do so if you are acutely aware of the net cash flow loss that providing credit terms will entail.
Follow up regularly
A simple reminder to your debtors can result in quicker payment and set credit terms – seven, 14 or 30 days – are crucial to avoid bad debtors.
Some industries have their own peculiar ways of using credit terms as marketing tools:
A retail business should outline its different forms of payment at the point of sale, on the website, and in brochures (where applicable). Small retail shops with larger competitors may have to contend with “store credit cards” and “gift vouchers”. To counter, make sure that all major credit cards are accepted and ensure that gift vouchers are sold in the store as well. A small business may not be able to match store credit to retail customers and will probably not have the infrastructure required to do so. That said, a smaller business will be able to differentiate in other ways.
Professional and Service Industries
One of the major hurdles of professional and service firms is the charge per hour framework that so many businesses find themselves in. Turn this around by providing fixed price agreements and pricing up front as a marketing tool. This alleviates the seamlessly endless struggle of getting customers to agree to pay for hourly work and minimises the need to write-down invoices.
Credit terms are probably used most as a marketing tool in the manufacturing arena. This is where credit application forms have the most use and where businesses should take the most care in screening potential clients. Because capital requirements may be large with working capital tied up primarily in raw materials, receivables days becomes a crucial financial KPI to watch as well.
If credit terms become the only way your manufacturing firm is able to differentiate itself from the competition, then the business is putting itself at great risk. Try to establish another point of difference such as delivery time, product customisation options, quality assurance.
A business that does not differentiate in any of these areas is purely a commodity and will be forced to fight on price and credit terms alone. A double hit as the first depletes net profit while the other depletes cash flow and working capital.
We All Count can help you understand the impact on your cash flow of either offering credit terms or reducing your days in receivables. It could be significant and it’s different for every business. If you’re interested in finding out what it looks like for your business, get in touch today.
General advice warning: The advice provided is general advice only as, in preparing it we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this advice, you should consider how appropriate the advice is to your particular investment needs and objectives. You should also consider the relevant Product Disclosure Statement before making any decision relating to a financial product.
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