Credit Control 101
That Sinking Feeling – Is That Water Around Our Ankles?
You’ve been doing business with them for five years now, and they’ve always paid their bills – eventually.
There was a time a few years back when credit tightened up and they ran their account out to $80,000 but they paid it off over the next year, got things down to about 6 weeks’ worth of purchases from you and stayed there – until now. Now, they’re into you for more than $100,000.
They are not returning calls, and you’ve heard that you’re not the only one they owe.
What do you do?
Figure the Cost?
The first step is probably to do whatever it takes to break you out of the mould of thinking that you have to deal with any customer on these terms – their terms! What are the real costs to you of taking their type of business?
It’s A Long Way Back
If your gross sales margin is 33%, and you lose $100,000 in receivables, you will be faced with increasing your sales by $330,000 just to get back to Square One. That’s leaving out the fact that increasing sales right now might be very tough to pull off. Even if we could, there would be the wear-and-tear factor on everyone in the business as you scrabble to do the extra business required – just to fill in the hole.
Then There’s the Bank
If you are running an unsecured overdraft with your bank to fund part of your working capital requirements, they will probably have advanced that on the strength of your Balance Sheet – which used to show your debtor’s account as a $100,000 asset, offsetting your liability to the bank.
Your Balance Sheet is now $100,000 light on assets and, like most banks just now, your bank is probably highly risk-averse and keenly interested in running your current accounts against their newly-raised standards for business overdrafts. Expect a call, reclassification, adjusted interest and – probably – a restriction on your limit.
What happens when you are hit with the double whammy – your debtor is not going to pay you, so you’re already $100,000 of working capital short, and your bank reduces your overdraft on the same grounds? You’re now $200,000 short, that’s what happens!
And all through no fault of your own? Really? Or was there something that you could have – and should have – done long before this?
Are You A Business Or A Bank?
Let’s do a couple of sums based on the simple facts of this story: You’ve carried this customer for say $60,000 (and occasionally for a lot more) continuously for 5 years. During that period your bank has been charging you an average of 12% on your overdraft, or 1% a month in round figures.
You’ve been charging your customer nothing.
So, you’ve provided this customer with more than $600 in interest savings a month for 60 months – a subsidy to their business from yours, of more than $36,000!
Mind you, unlike your bank manager’s treatment of you, you didn’t call your customer in to your office to examine their trading figures and review their account every year – though looking back now that would have been an excellent idea. You just let them take as much out of your working capital as they wanted each month – and thanked them for their business.
Maybe the bank knows what it’s doing when it reviews the affairs of those who owe it money, and regularly reassesses their on-going ability to repay. Maybe they actually know how to manage loans to other people. Do you? It doesn’t look like it.
Up until now, that is.
If You Don’t Watch Your Money, Who Will?
If you’re going to lend money to someone whom you barely know, and about whose business finances you know even less, would it be a good idea to require a level of security from them that is something like that for which a bank would ask?
Would it be a good idea to have a formally constructed Credit Application Form, requiring a level of information on which an informed lender (that will be you, if you go ahead) could make an informed judgement before giving them access to your money?
What I’m going to share next is a simple solution that has come out of coaching my clients:
In Place of a Guarantee
Would you ask for the same type of guarantee that the bank asks for? Many business people object to giving personal guarantees for commercial debts – it’s almost a custom! So, here’s a simple alternative:
Ask for a personal guarantee and when they decline, accept their position and compromise by asking them for their credit card details with the assurance that you will act on them only in the instance where an unforeseen circumstance might prevent them from honouring their agreement to pay their account when due.
Anyone who refuses this request must know something you don’t about their intention, ability or habit of paying their debts. If they have any hesitation at all about supplying you with a simple fall-back arrangement, they must suspect that they may not keep their word – in which case, why would you give them credit in the first place?
Your Credit Application Form will contain a clause authorising you to immediately draw against their credit card should an account become overdue. If, at some time in the future, the situation arises in which you attempt to draw against their card, and it is rejected, at least you’ll have an early warning that they have just become a high risk client, and you are more likely to face reality, and begin action quickly.
Bottom Line Question on Credit Risk
If you give a customer credit, and don’t put guarantees or payment alternatives in place, and/or don’t enforce your terms as and when they are due, who is at the heart of the problem here?
Banker’s Advice
By the way, ask any banker and they’ll tell you they don’t make money lending to people; they make money getting paid back!
Does your Trade Credit Policy need a serious overhaul? Would you like some assistance that is specifically tailored to your industry and situation? Feel very welcome to ask for our help on this one. Whether it’s a template from our archives, a chat to set you straight, or an assessment of your suitability to invest in business coaching, we’re looking forward to talking with you.
