This Credit Risk is Threatening Your Business

Author: Larry Chester, President

Companies establish credit policies for good reasons.  Unless you are doing credit card sales (and there’s even some risk there) you are sending product or services to someone that has promised to pay you.  You are, in effect, loaning them money.  You are acting as their bank.  So, just like a bank, it’s reasonable for you to establish terms and conditions around the money that you’re loaning them.  How much will you loan them, and for how long?  These are important questions, and companies usually only ask them  at the start of a business relationship.   

Even under normal circumstances, business has its ups and downs.  Sales rise and fall.  The cost of raw materials change.  Interest rates change.  Customer interest changes, and you need to react to it.  You track how things change in your business on an ongoing basis.  But once you establish a credit policy with a customer, companies rarely if ever review their situation to make sure that the credit policy that they established is still valid.  Of course with COVID, business fortunes have changed dramatically, and a business that was stable last year might be in a tenuous state right now.   

In fact, even though your business may have come through this financial crisis in fine shape, you may be standing on the edge of a precipice because of one thing that you have little control over – your accounts receivable.  You may be fine, but if your largest customer is struggling, that large receivable balance you’re depending on might be worth nothing because they are unable to pay.  

Here are five ways that you can check on your customers to make sure that they are still worthy of the loan that you’re granting them week after week: 

• Talk to them.  Seriously, just call and have a conversation with them about how their business is doing.  What did last year look like and how does the coming year look?  You don’t need to ask them for financial statements, but you certainly know the questions to ask.  If you’re uncomfortable asking them about their sales, ask them how their staffing was affected last year, or ask them how their bank has been treating them, or ask them if they’re looking at downsizing their facility.     
• Check their credit rating with a service like D&B.  They survey companies all the time to make sure that they have up to date information on their payment habits.  If their rating is slipping, it’s time for you to be cautious.   
• Watch their payment practices carefully.  Be sure that they don’t start delaying payments.  If they do, reach out to ask about being timelier with their checks.  If those payments start stretching out further, that’s a huge warning sign. 
• Be careful about orders that are suddenly larger than they have typically placed in the past. Some companies, in anticipation of a problem with their credit line, will order significantly more inventory so that they have the inventory on hand in case they get too short on cash to buy more.   
• Check with their bank.  Just like you checked their credit references when you first granted them a credit line, there’s no reason not to check in with the bank again.  It might be strange to check credit references.  But their bank might give you some information that would be helpful. 

But you can’t check on each customer every week to make sure that they’re still OK.  Here are some steps to make sure that you control the amount of outstanding Accounts Receivable that you have, and improve the likelihood that you won’t be stuck holding some worthless paper. 

• Reduce the size of the order quantities that you accept from your customers. 
• Call them the week before invoices are due to make sure that everything is in order, and they’re going to pay the invoice on time.   

• Shorten the time that you have given them to pay your invoices. 
• Ask them for a deposit for larger orders. 
• Provide a discount for early payment.  Agreed that nobody wants to take an additional 1 or 2% off the top of their collections.  But it’s better than waiting and wondering if you’re ever going to get the payment. 
• Move from check payments to ACH payments and consider taking credit cards.  This assures that you get your payment within 24 hours.  That’s a lot better than waiting for your customer to get the check signed, go to the post office to buy stamps, stuff the envelope, and leave it for the mailman.  All of that activity could take another couple of weeks. (Seriously, it’s happened.) 

Managing your company’s finances takes more than just looking at your income statement at the end of the month.  It means actively managing every part of your company that affects cash – money that you spend or money that you receive.  From payroll to inventory, from invoicing to paying bills, from collecting cash to signing long term leases.  Each of these contributes to the financial core that makes your company run – money.  And, you actually have control over each aspect of it.  Even Accounts Receivable, which is totally dependent on your customers opening up their wallets and checkbooks, is within your control.  You are responsible for the terms and conditions that set the manner in which your customers buy from you, and pay for those products and services.   

If you aren’t happy with the results that you’re getting, then do what you need to do.  Those payment terms are what you set up when your relationship with the customers was established.  You set it one way before, you can set it a different way now.  Because the world is different, and the circumstances in which you operate are different. 

Make changes today that affect profitability tomorrow.