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Tuesday, March 24, 2009

Cash is still king

The typical response of a business in hard times is to start cutting costs. But managing cash more effectively can have equally significant results. According to the Credit Management Research Centre (CMRC) at Leeds University, there’s one and a half times the volume of the primary money supply (from banks and financial institutions) swilling around in unpaid debt. Since over 80% of B2B business is done on credit, revising your credit policy, improving debtor management or even outsourcing parts of the equation can make a big difference.

Implement and communicate your credit policy

A survey by the CMRC found that trade debtor liabilities are the major and riskiest assets on corporate balance sheets, representing up to 30-35% of total assets. Trade credit, it says, is a key source of funding for companies, particularly at the smaller level, where it is typically twice the size of funds from bank credit. But it also points out that this is a two-way street. Credit is both an asset and a liability – many companies, particularly those at an intermediate point in the value chain both use trade credit as customers (accounts payable) and provide it as suppliers (accounts receivable). The key is balancing the two to improve cash flow.

The Better Payment Practice Group has been campaigning over the past few years to improve payment terms for small businesses. A good starting point, it says, is to establish a company credit policy which includes credit limits, both in days and sums outstanding, and a framework for staged payments. However, the CMRC research says that for small businesses this is a particular sticking point. Its report found that 52% of all companies had a written credit policy, but at the smaller-end the figure was much lower – a separate online survey by the BPPG found that only a quarter of small firms confirm their credit terms with customers in writing.

The CMRC points out that now is a good time to revisit your credit policy. “Pro-active credit management is necessary to cope with constant change to adapt to market and economic conditions and that may result in the need to make a change in any credit policy,” it states.

A good credit policy should be prescribed by the senior management of a company but it must also filter down to the different levels of the business to ensure it’s applied. Part of the problem in credit management is that if the policy is not part of common parlance with customers, sales, marketing and account management staff are likely to invent their own credit terms to win business and then pass the buck when it comes to chasing debts.

Focus everyone on debtor management

Debtor management is also a good discipline to focus on – and here the organisational challenges come into sharp focus even in the smallest of company set-ups. Debtor management attempts to pull together the different and often conflicting interests within an organisation towards the common goal of ensuring a debtor pays up the agreed sum on time.

The problem with debtor management is that different parts of your company have different agendas. Sales wants to maximise the value of a deal – and if given carte blanche will do everything it can to ensure the customer gets the best credit terms available. Support will want to ensure that it’s delivering consistent service to the customer on an ongoing basis, regardless of whether they are actually paying their bills. Finance is responsible for chasing the payment, but won’t want to step on anyone’s toes and ruin an ongoing customer relationship.

The financial systems and processes a company uses to log and communicate customers’ ongoing payment situation can help. When a payment is overdue, for example, a flag to the sales team to not continue advancing credit to that customer and to the support team to mention the outstanding payment on an account will often spur the customer into action – preventing the more heavy-handed collections that kick into place when a customer becomes a bad debt.

Taking a risk-based approach to debtor management is also a good idea. To take control of a credit situation, a company needs to understand which customers are least likely to pay on-time, what their credit-worthiness is, where the greatest exposure lies (if for example a handful of large customers account for most of its sales) and what the impact of non-payment would be on the ongoing health of the business – in other words, how much risk it can afford to take.

Drafting in a third party

Involving third parties is another option, one that enables management to focus on its core business while handing over financial management concerns. One approach is to factor debts, where you effectively sell your invoices off to a third-party factoring company. The third party will pay you up to 90% of the invoice value up front, easing the impact of customer delays on cash flows.

One potential downside of factoring is that customer relationships could be damaged if a factoring company is too heavy-handed – and it can be perceived as a sign of a company in trouble. You also might still need to step in if the debts turn bad as the arrangement cannot be terminated until all the debts are settled.

There are other outsourcing options too, such as invoice discounting (where the third party gives you an advance on your debt but you are still responsible for chasing it), credit insurance and using debt collection agencies. In practice, firms will use a combination of devices depending on their situation.

The CMRC survey found that late payment was more of an issue for small firms, where average debtor days was 43. And despite the introduction of the EU late payment directive in 2002, a majority were still not making customers aware of it. Small firms told the CMRC they would wait an average of 39 days before withholding the supply of goods to a late payer – compared with 22 days for large companies. Clearly small firms are still seen as a soft touch when it comes to credit. Perhaps now is a good time to get tough.

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