Continuing our post on evaluating your business credit and collections policies.
4. Understand your risk, can afford it.
Do you have enough sales to support the extension of credit, or is your business still “hand to mouth?” Are you extending credit on big ticket items that will disproportionately impact your cash flow or risk? What are your own payment terms to your vendors? How bad will it hurt if a debtor defaults and you end up taking them to collections? We have seen instances of small businesses expanding their business with a few large sales on credit, where an otherwise thriving business has been brought to its need by the default of only 1 new, but large account. You must understand your financial position, and your own risk in extending credit before extending credit to others.
5. Do you have the internal systems to manage receivables and collections?
Do you have staff that is qualified to collect customer accounts? Do you have software that allows you to adequately track the accounts? Do you have the internal systems in place to prove the debt if you are ever challenged by a customer? There are excellent software packages out there to help you track your receivables, but don’t forget you also need the paper trail to prove the debt should you ever end up needing a collections professional.
6. Understand your volume of transactions and how much of those transactions are on terms.
If you have only a few clients, and all are on terms, one default could devastate your business. If you have a lot of clients, and only 1 defaults, while you might be hurt financially, it could be survivable. Understand the dynamics of your client base, how many are on terms, and how long those terms are. It is imperative to spread the risk as thinly as possible to be able to adequately survive a potential default.
7. Watch your margins.
Businesses that run on thin margins can usually least afford the extension of credit to their clients. Businesses with healthier margins can typically better afford the extension of credit. Typically, the better the margins, the safer you are extending credit. Build into your margins your own cost of capital. If you offer interest free terms, but are financing inventory on credit cards paying 19% interest, then you are significantly impacting your margins, even if every customer pays on time. If you have factored in a certain level of default, factor in the cost of collections when evaluating your overall operating margins..