Would you like to provide loans to people you didn’t know very well? It doesn’t sound too wise, but many businesses are in the finance business by default. In effect, when you offer invoice payment terms to your customers, you’re providing short-term loans to them. Companies that don’t have sound credit policies and procedures to protect their business are taking unnecessary risks and can jeopardize their existence. Here we’ll look at ways to minimise your risk with credit policies and procedures.
Sales on credit can come with a high cost
It is necessary to overlook credit policies and procedures. Although sales are the lifeblood of business, many companies closely focus on sales and overlook the creditworthiness of their customers when providing invoice payment terms. Even if customers eventually pay, but pay late, it causes cash flow problems and a lot of stress for business owners and managers.
A study that compared payments to businesses around globe found that compared to other countries, Australia is notorious for late payments to businesses. According to a study, Australian businesses were being paid 26.4 days later than the customary 30-day payment term. In comparison, the next countries for late payments were Mexico and South Africa with the average lateness of 18.6 days and 16.5 days, respectively. Due to the 26.4-day tardiness of payments, this means that Australian companies are waiting an average of 56.4 days, from the date of the invoice before being paid. Some accountants state that the accumulated number of debtor days outstanding is a ‘silent killer’ of businesses. The problem gets worse when you add in ‘bad debt’ that’s never paid. What procedures can we take to stop this silent business killer?
Starting out right with credit policies and procedures
To prevent cash flow problems, it’s vital that your company has sound credit policies and procedures to ensure that your customers will be able to pay you when their accounts are due.
Sound credit policies begin with the parameters for how you will deal with granting credit and what happens afterwards when customers are late or do not pay at all. The type of topics a credit policy should cover include:
- When will you need to submit a credit application?
- Will you check references and the company’s credit report?
- What are the standard terms of sale?
- Is there a minimum time in business before you will grant a customer credit?
- Is the business in a high-risk industry?
- Will there be any exceptions to terms of sale be allowed?
- Who can guarantee/sign the credit application?
- How will credit limits be set, and when can they be exceeded?
- When will a late customer be excluded from receiving further purchases or services?
- How often will customers be contacted with regards to overdue balances?
- At what stage, will an account be turned over to an collection agency?
The credit application as the first step in credit policies and procedures
A credit application is a type of agreement that sets the credit terms for a customer. The terms of the credit application are based on the policies you have set and should cover all possible scenarios. Some of the basics a credit application should include are:
- Contact details of the applicant
- Business structure
- ABN
- Details of directors, partners, owners and/or trustees
- Signature confirming the signer has read the terms and conditions and agrees to abide by them
- Contact details of at least three suppliers who are willing to act as references
- Permission to conduct a credit check.
To reduce late and non-payments, make it clear that you will charge interest for late payments and make customers pay any collection fees incurred. An effective application will ask the customer for trade credit references and permission to seek information from these references and credit reporting agencies. If you don’t have one, you will want to select a collection agency that you can call.
When the credit application is completed and received, you can follow up by calling the customer’s references to determine if they have been reliable in paying their debts in the past. For a nominal fee, you can get a credit report that shows negative claims or legal judgements against the customer. If you get warning signs that the customer will have trouble paying, you might want to deny credit or get a substantial deposit before supplying goods or services.
You will want to create creditworthiness criteria as part of your credit policy. If you can find them, you will want to consider your competitors’ credit terms to stay competitive.
Retention title over the sold products until invoices are paid
If you are selling products, it’s recommended that you include a retention title clause in the agreement. This clause states that you keep ownership of the products until the invoice has been paid, even if they have been delivered. For companies using this clause, there is a national register where they can document their interest in the goods.
Known as the Personal Property Security Register (PPSR), it enables businesses to register their interest in goods to protect themselves. For example, if a company goes bankrupt and holds products that hasn’t been paid for yet, the company that is owed money is protected, if it has registered the goods. By documenting its interest beforehand, it will have priority over other creditors who are seeking funds from the liquidation of assets. Find out more about the PPSR.
Make it easy for customers to pay you by getting the right information
The credit application will ask the customer where and to whom the invoice be sent to. Payment delays are often the result of the invoice being sent to the wrong person. Also, give customers as many options as possible to pay, such as by cheque, bank transfer, credit card and PayPal.
You must issue an invoice immediately after your product or service are delivered. Delaying invoicing sends the wrong message to your customers – if you delay invoicing, some might believe they can delay paying you.
Follow up on your receivables
This is where your credit procedures come in. If you don’t receive payment by the due date, follow up immediately with a phone call. Make sure that the right person has received the invoice, then enquire as to why the invoice remains unpaid. Request for a definite payment commitment date of payment and keep in regular contact until payment has been received. When it comes to collecting receivables, the companies that stay in regular contact is likely to get paid faster than its rivals.
When a customer isn’t responding to requests for payment, it’s time to call a collections agency. Most operate in a commission basis and receive a portion of what they collect. They will make phone calls and send demand letters on your behalf. If they aren’t successful, they will then discuss other options such as taking legal action.
Avoid unnecessary risk by establishing credit policies and procedures
Remember that by offering credit your company is in the lending business by default. Establishing and adhering to effective credit policies and procedures will reduce the risk, stress and cash flow problems that can occur when extending credit.
Consider business finance to solve cash flow shortages
Even if you implement credit policies and procedures, slow payers can cause cash flow problems. Some businesses use debtor funding to overcome this challenge. If you are considering this option, check out our loan calculator for an estimate of repayments. We have finance brokers available to answer any questions if you would like to find out more.
Are you looking to finance your next piece of equipment? We can assist you with your equipment finance needs. Contact us today!
Phone: 07 4639 1011 or submit an enquiry
LinkedinSource: Moula
DISCLAIMER: The above content is to provide general information and does not constitute financial, legal or other advice. This means that duties and requirements imposed on people who give financial advice do not apply to this content. For advice contact your accountant or legal advisor.