Credit Control for Small Businesses
by Sue Marchant on September 17th, 2007
Unpaid invoices can cause serious cash flow problems for a business, but many new business owners neglect to put proper credit control procedures into place or fail to manage their debtors altogether.
Efficient credit control is about managing risk, about knowing your customers and being aware of the level of risk they pose to your business. A well-designed credit control system prompts you to check customer’s payment credentials before accepting orders, offers guidance when deciding credit and payment terms for customers, and allows you to chase outstanding payments quickly and effectively. All of this, and it will also impress your bank manager!
Credit Checking
Effective credit control should start before the customer’s first order is accepted. But many new businesses are so happy to see orders coming in, that they don’t think to check out their customer’s payment credentials. This can be a costly mistake, especially if your order values are very large or you offer long payment terms.
New Customers
A credit check tries to determine how ’safe’ a risk the new customer is. It establishes if the customer:
* Is legitimate
* Usually pays on time
* Has had payment troubles with other suppliers
* Is about to go bust
A new customer’s payment history can be checked through a credit agency, your customer’s company accounts or by taking references from the customer’s bank or another supplier.
Existing Customers
That a customer has always paid on time is no guarantee that he will do so in future. Circumstances change and a formerly sound business may suddenly find itself in trouble. Both are good reasons to credit check your existing customers on a regular basis. To focus your efforts, sort your customers by value of orders placed and check the top 80%. Flag and review any credit check results that have changed.
Repeat credit checking is also useful if a customer has not ordered from you for a while. For example, if most of your customers order monthly, credit check all customers re-ordering after a six months interval.
Invoicing
Goods should be invoiced on the day they leave your premises. It is good practise to run invoices at the end of each business day, irrespective of how many transactions have gone through. Most business accounting software packages can be set up to do this automatically. Send all invoices out promptly and/or email a copy to the customer.
Make sure your invoices clearly and prominently state the payment terms. Include a help line number and politely request that the customer notifies you immediately of any problems. Deal promptly with any such communications.
Risk Reduction
A number of techniques are available to reduce your business’ exposure to ‘bad debts’. They are commonly used for dealing with high-risk customers, but can be used throughout the business if cash flow is critical. This list is not comprehensive, but will give an indication of what can be done:
* Request part payment before supplying goods or services. Depending on the level of risk, request the remainder on delivery or allow standard credit terms.
* Set special (tighter) payment terms for the first invoice(s), with the proviso to relax the terms once a business relationship has been established.
* Offer an incentive for early payment, such as 1-2% discount for payment within seven days, if your standard terms are 30 days. In addition to speeding up payments, this method helps to reduce bad debt. However, early payment incentives can be expensive and you may suffer a ‘double hit’ if a customer takes the discount and then still pays late.
* Alternatively, offer a prompt payment rebate to your regular customers. This is usually calculated quarterly in arrears and issued as a credit note against future orders. It therefore does not affect your cash flow, and can be calculated just on invoices settled on time.
Credit Control
You can expect about half your customers to pay on time. To receive payment from the remainder, you need a system that starts to work even before the customer’s payment is late, as the key to efficient credit control is prompt and decisive action.
* Before you start any debt control activities, ensure that all account information is up to date. Enter all received payments promptly into the ledger to avoid chasing a ‘paid-up’ customer for an outstanding amount.
* Send statements to all customers with outstanding balances one week before the end of the payment term. Some large corporations will only pay on receipt of a statement. Don’t be caught out.
* As soon as the payment term has passed without the invoice having been settled, you must contact the customer. The quicker this is done, the faster you will resolve the issue. Keep in frequent contact until the invoice is settled.
* If you regularly have large numbers of customers with outstanding balances, create a polite reminder letter that can be sent automatically at the end of the payment term. Remind the customer of the outstanding balance and request payment within the next seven days.
* Customers failing to pay after this date should receive a stern letter/email and a phone call. Refer to the terms and conditions the customer accepted when placing the order and request immediate payment. If the customer is a business, inform them that you will begin charging interest on the outstanding balance.
* If the customer is unresponsive, make contact by telephone. Establish why the payment is late and agree a payment plan. Note the name and position of the person you spoke to, time and date of the call, and make a summary of the conversation. Confirm the agreed details and the date the invoice will be paid in writing. Keep copies of all correspondence.
* Initiate debt recovery procedures as soon as the agreed date has passed or the debt is older than 60 days.
Outstanding debt is money that is not available to grow your business. Instead, it is a liability that affects your cash flow, and that can threaten your business’ survival. A well-designed credit control system, set up at the same time as your business, protects your assets and puts you in control. And considering the number of new business failures every year, it is well worth the effort.
