Six Key Steps For SMEs To Manage Credit Risk

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
  • 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.
  • 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.

The complete guide to managing and preventing bad debts in B2B

The complete guide to managing and preventing bad debts in B2B

There are three key drivers of growth in a business- product, sales, and cash collection; however, the third one rarely receives the attention it deserves. Businesses often focus on sales/marketing and product – while taking cash collection as a given. The success of many B2B companies depends on their ability to manage the receivables collection function efficiently. And this is a function that deserves more attention, investment, and, dare we say, credit than it usually gets.

When you sell a product or perform service on credit, you are also in the B2B accounts receivables collection business. The financial health of your company depends on how well your business can collect on sales. Unfortunately, it is often performed with inadequate forethought to the systems, staff, strategy, and tactics to deliver exceptional results. And businesses find that their customers are using them as a bank, with many overdue invoices impacting the cash flow and growth prospects of the company.

Here we will look at how it is possible to increase your company’s cash flow performance with better planning, execution, and technology

What causes bad debt issues for business?

Credit, or rather the lack of credit-risk strategies, can often lead to bad B2B business debts. The problems can intensify with the lack of efficient operating models and insufficient management focus.

Lack of credit risk strategies

Many businesses do not implement a robust framework for credit-risk assessment. They do not follow the global best practices that reduce customer delinquency and debt collection. Not accounting for credit risk can lead to unhealthy business growth. It expands the customer base but depresses the profitability.

Companies with a credit risk framework often do not monitor pre-delinquency or follow the same approach for each bad debt. These companies seem to follow the same settlement strategies for all delinquents instead of adopting a customized approach for each such customer.

Lack of specialized staff for debt collection

Most companies do not have a specialized debt collection team, and they mostly rely on external agencies for the same. Some outsource this job to call-center agents who lack proper training to assess a customer’s situation. These agents, thus, fail to provide the right settlement options to these customers.

When the responsibility for collections lies between multiple departments, it is difficult to establish clear ownership of credit risk. Often, such companies lack staff that specializes in credit and risk management.

Lack of management focus

Top executives seem to be more occupied by transformation, innovation, and digitization that accounts receivables & collection is usually not in the spotlight. Bad debt figures don’t often feature on the agenda, making it harder to improve the situation.

How does bad debt, when left unchecked, impact a business?

Bad debts are never good for a business. They affect company finances as well as the accounting process. Bad debts often complicate the accounting process making it difficult to comprehend when a sale was completed. Accounting for an unpaid sale requires a variety of collection and reporting procedures.

Preventing bad debts is essential not just for the company’s financial health but also to minimize reputation and relationship risks from the collection process.

How can one manage bad debts effectively?

Debt management is vital to a business as it ensures that the company has enough working capital to reinvest and grow. Effectively managing debt requires some thought and planning and can be controlled with these simple steps.

Implement a credit policy

Most businesses have an informal arrangement for supplying goods and services. Not having clear, written terms of trade can lead to several disputes creating bad debts.

B2B companies require a firm credit policy to ensure their continued growth. Before offering credit to new customers, companies should conduct a thorough credit history and business reference check. Document the terms of business and the credit limits, and initiate business only when your customers understand, accept, and sign the business terms. 

Implementing new payment terms and conditions is better done with new customers or those looking to extend their credit limit. Introducing new terms to existing customers could upset them and affect their loyalty.

Avoid pricing disputes

Customers are more likely to pay you on time when you provide them with the right information on documents and invoices. Disputes can create bad debts that can significantly impact the business.

All your documents- quotations, invoices, contracts, purchase orders, and estimates should refer to your terms and credit policy. Make sure that the invoices and financial statements clearly show the amount due and the due date. The company’s billing address and bank account details should also be present on such documents.

It is a good idea to check with the customer if they need any additional information to expedite the payment. Indicating collection charges for overdue accounts on your invoices and statements can discourage late payments.

Use credit management software solutions

Well-maintained information is the key to good debt management. There are many credit management software solutions available in the market that can ease your company’s debt management process. These software solutions can closely monitor your debtors’ ledger and keep track of the outstanding payments. These solutions also offer regular reporting to help identify trends and patterns before they can impact your business’ cash flow.

Provide multiple payment options

One of the simplest hacks for getting paid outstanding invoices paid quickly is to add a multitude of payment options (credit card, bank transfer, cheques) – from a ‘Pay Now’ button on your invoice to enabling debt financing solutions – where you customers can get the outstanding invoices financed and pay you while they manage the repayments. The simple philosophy is to provide no excuses for your customers to not pay you – something which we adopt here at ezyCollect as well.

Implement AR automation

Accounts Receivables automation modernizes the accounts receivables process through automatic, electronic systems that decrease repetitive and time-consuming tasks. It frees up time for your accounts receivables team to chase payment and get the cash in to mitigate bad debts, rather than wasting time on printing and posting invoices.

AR automation improves the accuracy of invoicing details, leaving little to no room for an excuse for late payments. The AR team gets more time to chase payments and handle exceptions making collections fast with less delinquency. 

Strengthen your delivery systems and implement the practice of keeping signed dockets as proof of delivery. When you automate the AR process, it becomes possible to send invoices ahead of time, discouraging customers from making late payments. It can also send automatic reminders when customers deviate from your trade terms.

Review credit limits of your customers

Review the credit limits of your customers regularly. Look out for warning signals which could indicate that they may be facing financial problems. Check on all customers, even the long-standing ones, to monitor changes in buying habits or an increasing level of debt.

Wherever possible, refrain from doing business only with one substantial customer. Customer concentration risks outweigh the benefits. Be careful of customers who are expanding rapidly as their business growth can sometimes affect their ability to pay. Do exercise caution when handling requests for extending credit.

Stop supplying to customers who do not pay their accounts on time. Initiate a discussion about the situation and try and reach a settlement for payment of past supplies.

Importance of onboarding new customers with comprehensive credit checks

The core of a sound onboarding practice is to ensure that potential clients can pay for your goods or services. Implementing complete business credit checks allows you to access a client’s payment history, giving you useful information about their ability to pay, now and in the future. When you know a client’s potential payment pattern, you can make an informed decision if and how you would like to conduct business with that customer. The existing process of getting trade references and having your customers and sales teams fill out forms isn’t the most effective one – you might consider investing in a service or resource that can complete comprehensive business credit checks for you rapidly and help you transact with the right customers for your business

When you have insight into how a potential client manages financial responsibilities, you can make amendments to your payment terms and credit limits. Customizing payment terms for different customers helps safeguard your business from unreliable clients and cuts down the risk of bad debts. For instance, if a credit check indicates that a potential customer is a payment risk, you may front-load the payment terms or not offer credit at all.

Credit checks can be invaluable to mitigating risks and protecting your business from potentially expensive mistakes.

In Summary

B2B businesses face several challenges when collecting outstanding payments from delinquent customers. Developing a well-structured process, leveraging digitization, and upgrading your teams’ resources and capabilities can maximize recoveries and prevent bad debts. With an increased focus on debt management, companies can reduce high costs and lost income and enhance customer focus, customer engagement, resilience, and profits.

Why it’s your business to know your customer’s credit rating during a recession

Why it’s your business to know your customer’s credit rating during a recession

The Australian economy is currently experiencing its biggest economic contraction since the
1930s. Australia’s triple A credit rating is intact but on a negative slope, according to credit rating agency, S&P Global. In June, the Reserve Bank of Australia (RBA) confirmed there is considerable uncertainty about when the economy will recover.

What is certain is that the financial contagion of the Coronavirus pandemic has hit every industry. The Organisation for Economic Co-operation and Development (OECD) report that some industries like arts and tourism are in full shutdown. Meanwhile, others such as construction and professional services have declined by half.

Economic inactivity puts a huge question mark around a business’ ability to repay its debts. That means that previously creditworthy businesses may now be bad debt risks; prompt payers may quietly start to withhold payments.

Does your company know which customers have a deteriorating credit rating?

Key points

  • Economic inactivity affects a business’ ability to repay its creditors. More debts can become overdue.

  • A credit monitoring service alerts your company when a customer registers a significant credit activity in the wider market.

  • Your company’s credit risk exposure increases as your customers’ financial health declines.

  • A credit monitoring service identifies credit risks to your company by presenting crucial payment, court action, and company officeholder information about your customers.

Get Started with ezyCollect’s Credit Insights

What is a company credit rating?

A credit rating or a credit score is an indicator of a business entity’s likelihood to meet its financial obligations. A credit reporting bureau like illion analyses dozens of credit rating variables including an entity’s credit history, publicly available financial and organisational information and even court actions to determine its creditworthiness and financial stability.

To arrive at an overall credit appraisal for an entity, illion for example, will assess the likelihood that the entity will experience severe financial distress or failure in the coming 12 months, as well as its risk of paying severely late.

What is business credit monitoring?

Credit monitoring is a risk mitigation service provided by credit reporting bureaus. A credit
reporting bureau will collate, analyse and report on a business entity’s noteable
commercial credit activity as it trades in the marketplace. Changes in a company’s credit score can be picked up quickly by a credit monitoring service.

Many companies that offer trade credit to their customers rely on a daily credit monitoring
service. That’s because companies want to know when their customers are showing the first
signs of financial distress. Think of it as an early warning system to avoid potential bad

Above all, a company’s credit risk exposure increases as its debtors’ financial health declines.

Credit monitoring in a stable economy

In a stable economy, employment and growth are steady and it’s business as usual.
Businesses can be more certain about which customers need close monitoring. Depending
on its sector, a business may confidently predict the customer segment that is likely to
register the most payment defaults, bad debts, and insolvencies. That becomes the customer
segment in which they focus their credit monitoring service.

In Australia for example, illion publishes a quarterly Late Payments Analysis and Business
Expectations Survey
. The slowest paying industries have been consistent for some time:
retail, mining and manufacturing often top the list. Seasonal fluctuations also generate
predictable payment trends—we see retailers paying their invoices faster after the busy
Christmas period.

Credit monitoring in a recession

During an economic downturn, consumers and companies hang on to their cash and the entire supply chain suffers. In unprecedented times as we have seen with the COVID-19 pandemic, some businesses will quickly grind to a halt.

Therefore, during a recession, the usual payment patterns do not apply. Many more businesses become susceptible to cashflow constraints as financial pressures ripple all the way down the supply chain. Previously good payers may not pay on time. A company’s credit rating score could change more frequently than usual as trade credit activity fluctuates.

Most disturbing in a health pandemic is how quickly cashflow cliff dives and businesses can fail.

Get Started with ezyCollect’s Credit Insights

What credit monitoring tells you

Companies in financial trouble aren’t quietly slipping away. They are registering negative
credit activity in the market. However, without credit monitoring, it’s almost impossible for a
supplier to know its customers’ bigger trade picture.

Credit reporting agencies like illion can collect and feed back credit rating data about your customers. For example, illion’s credit monitoring service can alert your business when your customer registers a change in significant credit activity:

  • Collection Notification
  • Court Actions
  • Director Change
  • Financial Change
  • Public Filing Notification
  • Status Change
  • Score Change
  • Shareholder Change

What credit monitoring alerts mean

Alerts are generally described as positive, neutral or negative events in relation to a
company’s credit rating. ezyCollect’s credit monitoring service brings these alerts straight to your dashboard.

ezyCollect’s dashboard includes credit alerts on your customers

A collection notification is typically classed as a negative event. It indicates that the
original creditor has given up trying to recover a debt and has referred it to a debt collection

For example, illion will issue a negative event alert about a business entity when it has
received instruction to collect an unpaid debt from it.

Court actions are negative events. The various courts across Australia are responsible for
providing credit reporting bureaus with data on writs or summons that have been issued to a
commercial entity in relation to an outstanding debt.

Director changes is a neutral event as it is a notification that a company officeholder has
changed. Still, it’s important for a supplier to know when their customers’ directors change.
This could be because a director may have signed a director’s guarantee that they will be
personally liable for their company’s unpaid debts. If this is the case, then the supplier would
want to know if that director moves on.

In Australia, for example, a business must keep its company officeholders’ details up to date
with the federal corporate regulator, Australian Securities and Investment Commission
(ASIC). Director changes are significant because officeholders have obligations to comply
with reporting and legal requirements.

Financial change is generally a neutral event as it indicates that a monitored company has
lodged its financials at ASIC for review.

A public filing notification is a negative event. It informs that a creditor of a business
entity has made an application to the court under the Corporations Act to wind up that entity
due to insolvency.

Status change alerts could be positive or negative as they relate to the current ASIC status
of the entity. An example of a negative alert is when ASIC confirms that an entity has moved
from ‘Registered’ to ‘ Under External Administration’. An example of a positive alert is when
ASIC confirms that an entity has moved from ‘Strike-off action’ back to ‘Registered’.

Score changes report that a company’s late payment risk and /or failure risk scores have
changed. These credit scores indicate the likelihood that a business entity will pay severely late and fail in
the next 12 months. Scores can improve, stay the same, or decline, and therefore generate a
positive, neutral or negative alert respectively.

Shareholder changes are a neutral event. ASIC notifies that a company has updated their
register of shareholders as required by law. Shareholder changes are important to know
because they indicate a change in ownership of the company which may affect employees,
suppliers and customers.

In summary:

During an economic recession your customers’ typical payment behaviour can deteriorate as
trade inactivity persists. A credit monitoring service can help you to quickly identify
customers that pose a heightened credit risk to your business.
Financial controllers and credit managers typically use credit rating insights to mitigate
foreseeable bad debt risks to cashflow.

Try ezyCollect’s Credit Insights for 2 months free including 3 free credit score checks each month.