How many times have you heard that the collapse of a major debtor caused the collapse of the business to whom the money was owed? Tragic indeed, but unfortunately credit management has become far too much of a science and has lost the art that used to govern it.
Granting credit to another company, or individual, is in fact a privilege given to that organisation/person – it is NOT a RIGHT! Why is it then that we feel it is our DUTY to grant credit in business? Maybe because the simple reality is that you will probably not get the business if you do not grant the credit. If you do not get the business, you do not meet the targets. If you do not meet the targets, you will either loose your job or your business … or both! But are the consequences of granting the credit and not getting paid any different?
What is the solution? Well, if you are in the position where you simply MUST grant credit to customers, the solution is to grant credit intelligently.
So, you have your standard credit application, which lists all the ‘right’ questions, has been vetted by your attorney and even contains that now standard surety clause. All relevant aspects of the completed credit application are checked by phoning other creditors of the applicant, obtaining a bank code, and running the relevant credit checks on both the applicant and its directors. Everything comes up clean, so you feel comfortable in granting the requested credit limit and you sleep easily until the day the debtor does not pay and, after some considerable time, you find yourself:
- either, having to visit your attorney (or the heavy-handed debt collectors who will cost your business far more than the debt they may collect), and eventually the courts, to assist you to possibly collect (many months later) some of the money owed to you.
- or, in the case of a liquidation, standing in line with a whole bunch of other creditors who all rank well behind SARS, staff, Banks and other secured creditors.
… in the meantime, the previous guardians of that business are living it up on your money!
Unfortunately, you missed out a couple of vital steps and failed to ask yourself a couple of vital questions, which we always used to place heavy reliance upon before the advent of the information age. These fundamentals held true for an exceptionally long time and seemed to keep the bad debt level far below the endemic levels prevalent in today’s business world.
What are these things that seem to be missed by that modern marvel called the ‘Credit Application’?
Asking the right questions:
- If this debtor goes bad on me, how many months of overall trading will it take me to recover the amount of cash I lost? Can I bear this easily?
- Am I exposing more than 1 month’s profit by granting this customer the requested credit? (please bear in mind that you can risk your profit at any time, but NEVER put your cost at risk!)
- How many months of trading with this customer (in isolation) will allow me to break even if the amount owed turned bad?
- Do I really know enough about this customer to entrust them with my money?
Sure, the above questions are not the sum of all questions to ask, but they are at least a start! If you feel uncomfortable with any of the answers, do yourself a favour and turn the business down.
Accurately assess the risk you are taking: In years gone by, and to the best of my knowledge this still applies today, we always did business with friends. A true friend does not disadvantage a friend! It appears the meaning of the word ‘friend’ has changed somewhat.
Okay, so times have changed, and we do not know all our customers intimately. Here are a few brief things we can do to considerably diminish the risk we are taking when granting credit:
- Know the Customer: Four Checklists covering 51 aspects of any business, when thoroughly investigated, will give you extremely good insight into the type of organisation (and its guardians) you intend dealing with. Start accumulating the information you need from the first time you, or your sales staff, visit a prospect. None of these issues appear on any credit application I have ever seen. It is utterly amazing how accurate a picture you build up.
- Hold the Sales department fully accountable for any bad debts: No business goes belly-up over night. The signs were clearly visible for any intelligent observer many months before the actual crash. Your sales staff should be strongly associated with all customers and part of their job is to gather, and interpret, intelligence. So, if a customer turns into a bad debt, recover the debt from the performance bonus you were going to pay your sales staff.
- Risk your profits, not your cost: As far as is practically possible, never allow the outstanding debt from any one debtor to exceed your average profit in any one month. Should a debtor collapse, you will have lost your profit for one month, but you will still be able to meet your own debts.
- Question Creditors: The credit application usually makes provision for obtaining credit references from at least 3 current suppliers of your prospect. What is overlooked, is obtaining a reference from 3 past suppliers, and ensuring that the current creditors you are obtaining references from have each been dealing with your prospect for at least the last 2 years. It is always best to have face-to-face interaction with these referees as you are far more likely to get the truth.
- Re-Assess your risk every 6 months: We tend to set a credit limit and from there on rely upon the payment record for making all future decisions. Wrong move! Circumstances change, people change, and markets change. At least once every 6 months you should re-assess whether your customers remain worthy of the money you are lending them. If they are not … fire them!
- Have an alternative for granting credit: Believe it or not, there are alternatives to granting credit. Here are just two of many:
- a prospect will often jump at paying you cash, 7 days, 15 days and even 21 days if the discounts you offer are attractive enough.
- register as a credit card merchant and get your money immediately whilst allowing your customer to still get at least 45 days credit (a ridiculously cheap option for you).
- Be clear on why you secured the account: People only switch their allegiances for particularly good reason. Be sure that you won the business of your prospect for positive reasons and not because you had been marked as the next ‘victim’.
Sure, these activities are a lot of work, but is the work not worth being able to have a good night’s sleep in the knowledge that all your debtors are good for the money they owe you?
Remember that internal misjudgements are six times more likely to cause business failure than external factors. The message is clear … keep objective help close at hand at all times, and if you do not have it, get it without delay.
Success in business is all about you!
QUOTATION:
Exercise caution in your business affairs; for the world is full of trickery. But let this not blind you to what virtue there is; many persons strive for high ideals; and everywhere life is full of heroism. (Desiderata)
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