In spite of the rise of online sales, the majority of business-to-business transactions are still carried out on credit: goods or services are delivered, an invoice is raised, and payment is made some time afterward. Credit is necessary in any developed economy in order to stimulate growth: using credit as a substitute for cash is essential because very few businesses have sufficient cash to pay ?on delivery?. It allows people to acquire goods and services without having to save up for them first, thus speeding up the sales cycle.
Of course, giving credit involves risk: if I provide you with my goods or services on a promise to pay, how can I guarantee you are going to settle your debt in accordance with our agreement ? or even at all? This is a major consideration for any business owner: how do I balance the risk of giving credit against the potential loss of sales caused by insisting on cash? The simple answer is that there is no simple answer! But assuming that the business decides to give credit, there are numerous ways it can protect itself and minimise the risk of late, or non-payment.
- Establish the customer?s creditworthiness. There are a number of ways of doing this, including taking references, carrying out county court judgment searches, examining the customer?s accounts, and doing background checks on its directors to see if they personally have a good credit history.
- Set credit limits ? the amount the business is prepared to risk on a particular customer at any time ? and stick to them. Review these limits periodically ? they can be amended up or down depending on the customer establishing a good payment history, and remaining financially sound. A customer?s financial status should be re-checked at least annually. If it has a poor payment record, reducing the limit will reduce the risk to the supplier.
- Set payment terms ? how long the customer will have to settle the debt, and the cost of late payment ? the entitlement to charge interest if the debt becomes overdue. Some businesses allow an early settlement discount to improve cash flow. Suppliers have a statutory right to charge interest on overdue accounts, but why rely on this when they can set and apply the rules themselves?
- Adopt robust systems to verify delivery, monitor payments, identify overdue invoices, take steps to collect any arrears; and suspend supplies if necessary.
- Adopt systems to deal with customer queries or complaints – inevitably these will arise, so it is important that the procedure is set out clearly to avoid customers trying to ?play the system? to delay payment. Deal with all customer queries and complaints quickly, efficiently, and in a firm but friendly manner, even if you think the customer is trying it on. Threats of legal action etc. should only be a last resort, if all other avenues have failed, and the trading relationship has completely broken down.
- Establish excellent customer relations ? for example by calling the customer on delivery to confirm that everything is ok with the order. This is particularly important with larger orders, and more difficult customers ?not only is it an excellent way to develop and improve relationships, it also reduces the risk of the customer raising a dispute later to try to delay or avoid payment. Some companies make a point of calling their customers shortly before the due date of larger invoices to confirm everything is in order, and that payment will be made on time.
- Incorporate retention of title terms ? these provide that ownership of the goods does not pass to the customer until it has paid for them, so that the supplier can repossess its goods if they aren?t paid for, or recover the invoice cost from an administrator if he wants to use those goods to continue the business of an insolvent company.
- Adopt written standard terms and conditions ? get these drawn up by a solicitor ? it?s a great investment ? and ensure that they are signed by the customer before doing business with it. These should be reviewed periodically and updated to reflect any changes in the law ? which happen more frequently than most business owners suspect.
- Monitor average debtor days monthly ? and if these slip towards or even above the standard credit term, take steps to tighten credit control procedures.
- Credit insurance ? insuring invoices against non-payment ? however this can be very expensive compared to the benefits of having excellent credit control.
- Invoice factoring ? invoices are sold to a bank (factor) for a discount, and the risk transfers to the factor; but this is usually part of the supplier?s overall financing strategy rather than credit control policy.
Businesses without robust credit control systems will find they are constantly short of cash. They will also find that management?s time is diverted away from the important things, like sales and delivery of the company?s product, onto chasing overdue accounts. This can be very damaging and costly. Reputable, trustworthy customers will not object to a supplier exercising its right to collect money owed to it in accordance with its credit terms ? as long as these are communicated clearly and adequately at the outset.
Customers who habitually pay late are taking unfair advantage of their suppliers ? using them as a source of free, unauthorised banking facilities. There are many reasons for late payment but my experience is that it is usually down to a deliberate policy, or poor administration systems by the customer, rather than genuine difficulties. Of course, difficulties do arise from time-to-time, and the supplier and customer should then work together to find a solution, particularly if the supplier wants to maintain a future trading relationship. But having clear and unequivocal rules and processes will minimise the risk of the problems becoming unmanageable, and the supplier losing a large amount if a customer goes bust, which is bound to happen eventually. It?s all about managing and minimising the risk.
? Alan R Price 2015