Successful Debtor Management

Published Date 22nd April 2009

Credit has become a way of life, many of your business purchases will be made on credit and the extension of a credit line will be something most of your customers take for granted. Therefore efficient credit control and debt recovery are of the utmost importance

Extending Credit

Most businesses will be required to extend credit and this credit will need to be on competitive terms, or customers may well go elsewhere. However a balance must be achieved in order to reduce the chances of overdue or uncollectable accounts. The development and execution of an effective credit policy is the best method of reducing this risk. The policy should cover all areas of your credit procedure from application to recovery. The terms of credit you extend will owe much to your relationship with your customer, what your competition is offering and what your needs for cash are.

Knowing your customer

Procedures for the approval of lines of credit for new customers should be put in place. A credit application form is a good way of finding out the necessary information on prospective debtors. Customers looking for credit will provide you with their business name, address, phone and fax number along with at least two trade references and one bank reference for this purpose. If the customer has a person in charge of payments, make them fully aware of your payments process.

Many potential credit problems can be eliminated before they happen through investigation and prudent judgement. This may be in the form of checking trade & bank references, looking through trade journals and using credit bureau checks (although you will need to ensure that you have obtained adequate consents before carrying out credit reference searches).

Conditions of Payment

Sound judgement is of vital importance since your credit extension policy should not be overly restrictive or overly generous. A restrictive policy may not be competitive and result in a loss of sales, while an overly generous policy will increase the chance of uncollectable accounts. Conditions to be put in place involve, how much credit will be extended, the period until the repayment is due and penalties for late payment. Take a look at what conditions your competitors offer and take into consideration what you can afford before finalising your credit line conditions.

New customers, or those you view as risky will often be set a lower credit limit with more stringent conditions than your more established customers, however, you should put in place a policy of reviewing the credit limits of all customers regularly.

Cashflow

When evaluating the credit line you are offering your customers, it is of vital importance to ensure you will have sufficient cash to meet your immediate needs. It takes self-discipline and good management to maintain a positive cash flow position within your business. Minimise the time between a sale and payment, keep detailed debtor records and report and act immediately on overdue accounts. Please refer to our Cashflow Forecast tool.

Invoice Discounting

It is advisable to try and avoid a situation where you need cash immediately but none is due in until the next week. One possible way of managing this situation is through Invoice Discounting. This service provides you with the immediate financing of a percentage of your account receivables. The balance (less costs) is paid as the debtor collections are received.

Payment Collection Process

The fundamental rule of good debtor management is to minimise the time between a sale and payment. In all credit agreements you should set out all terms of trading and state clearly when you expect payment. However delays in your own invoice and collection process will also result in payment delays.

Invoice promptly

A system must be put in place to ensure your invoices are accurate, get sent out promptly and are addressed to the correct person. A good credit control process will ensure that you invoice within 24 hours. Invoices should also clearly state payment methods and the date payment is expected.

Keep Records

Clear and accurate record keeping is a necessity and this will help you deal with customer queries efficiently. Keep records of all correspondence and conversations with your customers. Accurate record keeping helps you to keep a check on whether there are problems or delays on certain accounts. A Debtor Matrix helps you to individually chart how much credit you have extended to each customer and for how long (further details are provided below). A statement of account should be sent out promptly at the end of every month.

Follow up

A follow up procedure must be put in place as an account gets further behind, the balance may increase while the chance of being paid decreases. Once an account becomes past due, an agreed penalty should be imposed, if this is included in the Terms and Conditions of the debt, but a systematic follow-up procedure should also be used. This can consist of a series of letters or phone calls or both as required. No more credit should be extended on slow or doubtful accounts.

Debtor Management 

A problem can only be acted on once it is detected, that is why your business needs to keep a close eye on its debtors.

Debtor Ratios

Two Important indicators of the effectiveness of your credit policy are the Debtor Ratios. The Debtor Turnover Ratio measures the number of times receivables turn over during the year. Debtor Turnover is a good way to gauge the effectiveness of your company's payment terms. If this ratio is low, it may indicate that you are offering lenient payment terms or have trouble collecting debts. The Debtor Collection Period Ratio, tells you how long on average, it takes for you to receive cash after you have made a credit sale. The higher the figure, the longer it has taken. This is of particular relevance in debtor management, as there is a direct correlation between length of time outstanding and a bad debt.

Debtor Matrix

Problems in individual accounts can be detected through the use of a Debtor Matrix. This divides each customer's account into amounts that are 0-30, 31-60, 61-90 days old, and so highlights problem accounts. The systematic follow up procedure is of vital importance once a problem is detected, the procedure of timely letters and/or phone calls should ensure fitting contact occurs with the debtor. If this procedure fails to result in payment, options are still available to you.

Further Action

Legal action, a solicitor's letter will often have a greater impact than the letters you have already sent. However actually pursuing legal recourse is an expensive and time consuming process and should be the option of last resort. 

Factoring, this is the selling of your debt at a discount. While you will not receive the full amount owed to you, you are given an immediate inflow of cash.
Insurance can also be taken out against the risk of bad debts.

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