Six Key Steps For SMEs To Manage Credit Risk

Offering credit to your customers is an effective way of encouraging them to spend more on buying your products or services. In some industries such as wholesale, trade, or distribution – credit might be a requirement for doing business. Extending credit to your B2B customers could also help your business gain a distinct competitive advantage in your market.

While providing credit is good for your business growth, it exposes you to the risks of late payment and at times, non-payment. While this significantly impacts your short-term cash flow, it can also hurt your bottom-line and business growth in the long run. While some business owners may think they are not offering credit, they may already be doing so by sending an invoice after the goods or services are provided to the customers.

Balancing the risks of cash flow reduction and increased sales is the key to robust credit management.

The key risks of poor credit management include:

• Reduced cash flow: The increase in payment times could impact cash flow and the ability to buy replacement products or raw materials from suppliers is impacted. Many businesses look into debtor finance to manage this risk.
• Low-profit margin: Credit sales and poor credit risk management can also impact profit margins.
• Growing debts: Reduced cash flow increases the burden of debts that pose a major risk for the business. Large single transactions are more prone to debt risks – it makes it imperative that your business enforces a consistent accounts receivables process – ideally through automation.

If you offer any other invoice terms not based on cash on delivery, it creates a risk that the customers may fail to pay on time or fail to pay altogether. For instance, if you offer 30-day terms, it translates to credit of 30 days. If that timeframe extends to 45 days or 90 days, the credit gets further extended and increases non-payment risk.

However, with some customers who have a strong and long history of making full payments on time, the credit risk may not be significant. Despite this, there is a risk, even if slight, that your next invoice may not get paid due to a change in the customer’s circumstances or other factors (You can track these in real-time with Credit Insights from ezyCollect). Although these external factors may not be under customer’s control, the outcome is that their inability to pay on time affects your cash flow and eventually, your bottom line.

The first step towards effective credit risk management is understanding your business’s overall credit risk. This helps businesses reduce losses and build up capital reserves. It is crucial to implement a smart, integrated, and informed credit risk management strategy.

The key elements of an effective credit management strategy:

• Create a credit policy
  • The first step is to develop a strong credit policy that outlines your:
    • Objectives: Describe the purpose of the credit policy that can include the definition of businesses and customers that you plan to extend credit to as well as the terms. Determine how much credit you can safely extend and under what circumstances the credit will be offered. Determine the level of risk that your business can tolerate before setting down the terms.
    • Credit approval process: List the steps on transacting with new debtors such as assessing creditworthiness.
    • Credit limits: Define the elements that contribute to the credit limit of each customer. For instance, all new customers can qualify for a specific limit until the determined number of invoices are paid by them on time. You can also set the limits based on the customer’s risk rating.

• Assess debtors
  • The next step is to assess your customer’s credit rating to determine whether you can extend them credit and if so, what the terms need to be. If extending credit to a vendor or another business, ensure it is a legitimate business that is still trading. You can utilize the ABN (Australian Business Number ) or  ACN (Australian Company Number) to verify the business name and associated trading names if any.
    • Poor ratings will mean you can avoid extending credit or tailor your credit terms to the credit risk associated with any business. A customer or business that meets your defined criteria can be moved on to the next stage of entering into a contract.
    • From individuals, you will need to collect their contact and identification details, a signature that confirms they have read and accepted your terms, and approval to perform a credit check on them as required.
    • From businesses, you will need to get a minimum of three credit references, comprehensive information on the partners, owners, directors, and signature of credit applicant on the form to indicate they understand and accept your terms. Use an online credit application process to give your customers a great experience and get integrated customer late payment risk scores and payment failure scores
      • Run Company Credit Score Checks with ezyCollect using the ABN –
      • Eg: Short Street Investments ABN Business Credit Score
      • Eg: Hunter Gas Newcastle Pty Ltd ABN Business Credit Score

• Monitor debtors
  • As conditions and circumstances can change at any time without warning, it is vital that you monitor your debtors constantly. While obtaining your customers’ approval for performing a credit check periodically, determine from time to time whether they still qualify for credit. If their rating has declined, implement your credit risk management action plan as determined in the first step.

• Streamlined invoicing
  • Manual processes of issuing invoices are not only outdated but can lead to delays from your end, which translates to further delays in payment. At the same time, you can streamline the credit application form on your website by leveraging state-of-the-art credit application systems. This will help set the right tone for the interaction with your customers while minimizing delays in sending invoices. Update your bookkeeping system to ensure you have real-time information on each of your debtors and their payment schedule.

• Customer relationship management
  • Utilize a feature-rich CRM (Customer relationship management) tool to get timely alerts and payment reminders while ensuring seamless communication with your debtors.

• Insurance
  • Trade credit insurance protects account receivables and helps cut the risk of non-payment. You can protect your cash flow as the insurance covers up to 90% of the amount due. However, there are limitations to using credit insurance – because it’s a bit like locking the stable after the horse has bolted. A better approach would be to use credit scores and trade insights when you onboard a new customer.

Building trust is the most critical factor when extending credit to another business or customer. While it is always a great idea to start with ‘cash sales’ with a new customer, you can navigate towards credit offerings when the customer has built a strong payment history and inspires the desired level of trust.