Bad debt can be a serious setback for growing businesses with tight margins. A healthy cash flow position can quickly turn negative because of the cost of having met an unpaid order. Of course, building a business and expanding your customer base inevitably involves some degree of non-payment risk and the challenge is to mitigate this through sensible credit management measures. But, unfortunately, many companies only learn this from bitter experience.
The best way to avoid this pitfall is to ask an expert how to make informed credit decisions and optimise your cash flow. Here are the questions about growing a business safely that we hear on an almost daily basis:
What is the biggest pitfall for a growing businesses?
It might seem strange but one of the major errors businesses make is overtrading. Chasing sales is an adrenaline rush but a full order book is not an asset if new customers then leave you in the lurch. Your new-business strategy should utilise effective credit management to reduce the likelihood and potential impact of bad debt and help you achieve sustainable growth.
What does effective credit management involve?
The first principle is awareness. From the MD to the sales team, everyone should recognise the risk posed by a customer defaulting and understand their role in preventing it. Ultimately, credit management can only succeed if it is embedded in your company culture.
Second, know your customer. There should be a process in place to ensure you have all the details of each new customer, that you have carried out essential credit checks and that their payment behaviour is kept under review.
Third, customers should be in no doubt that you take credit management seriously. Be proactive and insist on signed contracts, conditions of sale and credit agreements. Make it clear that statutory interest will be charged on late payments under the Late Payment of Commercial Debts Act. Lastly, ensure your accounts payable team chase up unpaid invoices promptly, rather than leave the impression that this isn’t a priority.
How thoroughly should we research new customers before offering credit terms?
It’s not always realistic to insist on payment in advance or cash on delivery, especially if you are trying to secure a large order. At the same time, decisions about the creditworthiness of customers should be based on hard evidence and not the promise of future business or instinct. It’s important to carry out due diligence on individual buyers to determine their risk profile.
Don’t be convinced by a company’s web site or its entry in a directory. Unscrupulous traders can buy visibility so obtain a full name, business address and, if possible, home address for the company director.
Trade references or bank references should be up-to-date but it’s better not to rely on these alone. Credit reports and ratings are another useful resource but check these are based on the very latest company information available, as things can change quickly. Always ensure that the credit transaction is based on the specific level of credit that you want to extend.
What are the warning signs that a client might be about to default?
It’s important to monitor customer payment behaviour and be alert to changes from their established pattern. Be particularly wary of attempts to extend the payment date by a few days or disputes raised shortly before the invoice due date.
How does credit insurance work?
A credit insurance policy protects you against losses arising from non-payment of credit trade debts because of a customer’s insolvency or protracted late payment. It basically works like this:
- A credit-insured business checks they have a positive credit decision for a customer and the limit covers the total amount outstanding. New limits can be requested as necessary.
- The business fulfils the customer’s order.
- If the customer fails to pay by an agreed time limit, the business notifies the credit insurer, provides documentation and stops further deliveries.
- The insurer processes and pays the claim in accordance with the policy terms and attempts to recover the debt.
Most credit insurance is provided on a whole turnover basis. This usually means the insurer covers the majority of the policyholder’s business and the premium reflects, amongst other factors, the turnover of the business. It is also possible to arrange cover for strategically important customers or specific risks.
How can credit insurance help our business grow?
Every growing business depends on healthy cash flow. Credit insurance protects cash flow in the event of bad debt, as well as alerting you to high-risk customers before it is too late and instilling good credit management discipline.
If your growth strategy depends on selling overseas, an export credit insurance provider can support you when it comes to researching the risk of unknown markets and evaluating the financial health of prospective overseas customers, information which is not always readily available.
Finally, securing your receivables demonstrates that you are financially sound, which can often help you negotiate better financial terms when seeking investment capital. 
If you would like to find out more about credit insurance, then contact Coface.
