Staying afloat: credit management

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Once you set up in business it will be essential to manage your money. So how would you handle credit management? Colin Porterexplains the importance of debtor assessment

One of the many benefits of being a franchisee includes the ability to call on the specialised and highly-skilled knowledge and experience of the franchisor’s head office. This support can greatly reduce a franchisee’s business risks, however it’s important to remain vigilant against bad debtors and ensure your credit management is up to scratch.

In recent months, the Australian Securities and Investments Commission (ASIC) has identified a serious increase in the number of companies going into administration or being wound up.

According to quarterly figures released by ASIC in May, 1,123 businesses went into administration in February of this year; the highest monthly figure recorded since the Commission began releasing statistics in 1999.

A great deal of the literature around credit is focused on helping struggling debtors, but as businesses and creditors it’s easy to forget that giving credit where it isn’t due is an early part of the problem.

Because the credit we extend is in the form of goods and services, rather than money, the longer we go unpaid, the more it affects our own cash flow and our own debts.

Debtor assessment is probably the most important part of credit management as it tells you whether to extend credit, by how much, as well as what to expect from the debtor.

While performing upfront credit checks on new customers remains essential, the need to be monitoring all of your customers for adverse financial changes has never been more important.

Business owners need to be asking themselves, “In the current economic climate, how well do I know my customers?” Without the right credit management processes, you may even be doing business with a company that is deregistered, or in administration. Businesses often get stung when they find out they have been chasing a debt from a company that no longer exists.

How to assess a customer

Firstly, run a check on the customer to make sure it is a legitimate business still trading. To do this, you need the customer’s Australian Business Number (ABN) or Australian Company Number (ACN) to determine the business name and any trading names it uses.

Run those details through a credit reporting agency; this will alert you to any defaults or court actions that may be pending.

Credit testimonials, written statements that vouch for the relationship the debtor has with other creditors, can also be useful if you can ask the right questions of the creditors that best match your business profile. While these are useful, it’s worth noting that the debtor will choose to put its best relationships forward, so testimonials can give a false impression.

Once you’ve determined the financial state of the customer, set a credit limit. Just because a business has had a few question marks against its payment record in the past doesn’t mean you should avoid it altogether. Start with small amounts of credit and only extend as much credit as you can afford; remember, you have expenses to pay too.

The length of your credit terms should come into play at this point. Every business needs to balance credit terms that are attractive to customers but also serve its cash flow cycle.

For instance, on an industry level, it is typical to have longer credit terms in construction because of the nature of the work. The mistake many construction businesses make, however, is not being strict and enforcing these terms when an invoice is due, so remain vigilant.

Identify how long you are willing to wait for debtors to pay their invoices and build in some time in case you need to chase. You may also consider developing penalties for late payments and incentives for early payments.

Protecting your franchise from bad debtors

A proactive approach to risk management is the key to keeping your cash flow cycle in check as well as maintaining a good credit relationship with your customers.

Be sure you are familiar with your franchise’s credit policy and refer to it regularly. If you have someone acting as accounts receivable, their role is to monitor changes against the debtor’s initial credit assessment and act accordingly if there are signs of trouble.

In many cases, timely communication with the debtor is all it takes to keep the payments on track and the relationship in check.

How to stay alert

A credit reporting agency gives members the ability to monitor their entire customer database for important changes including court judgements, commercial defaults and ASIC changes.

If something is registered against a customer the member will then receive an email alert, providing the opportunity to contact their client to see what is going on and help decide whether they should be changing their credit policy or whether they should be still be doing business with them.

Risk management is about allowing for contingencies that benefit you in the long term, so a good credit policy should allow for financial mishaps and offer solutions that help you avoid expensive, time consuming consequences like litigation while keeping the customer relationship intact.

Colin Porter is managing director of CreditorWatch

Main image: findabankruptcylawyer.com; other images: debthelpdelivered.com

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