How can we develop an effective credit control policy that will make a positive contribution to the business? The first objective must be to ensure the correct balance of debtors and creditors, i.e. that the overall level of credit given to customers does not exceed the overall level of credit received from suppliers. This is easily checked by comparing the average debtor-days with the average creditor-days. However, that comparison alone will not suffice.
Consider the situation where we take an average of £50 000 of credit on an average of £100 000 of purchases per month, resulting in a figure of fifteen creditor-days. At the same time, we give our customers an average of £60 000 of credit on sales of £150 000 per month, which works out at twelve debtor-days. On the face of things, this looks good in that we are giving twelve days’ credit but receiving fifteen days’ credit. However, in reality, we are giving an average of £60 000 credit each month but only receiving £50 000, which causes a net outflow of working capital. In a situation where the business is seeking a rapid expansion of trade, this is likely to be a common occurrence, and the actual cash figures should not be ignored just because the ratios look to be acceptable.
The above imbalance might be addressed by offering prompt payment incentives to reduce the debtors’ figure. Alternatively, we could negotiate with our own creditors for longer payment terms, so that the average outstanding payments owed to them were larger that the debtors figure, say sixty-day payment terms rather than thirty-day. If the business is growing, the trade-off incentive to the suppliers might be the opportunity to deliver larger consignments of goods in one drop, requesting improved credit terms as an alternative to bulk quantity discounts. Remember there has got to be something in the deal to make it worthwhile to the supplier.
Another factor to bear in mind is that when trying to establish a balance between the overall debtors and creditors, it is not necessary for every single one of them to be in balance. For example, there may be one or two highly valued customers with whom you have negotiated special terms, e.g. extended credit for larger orders or long-term contracts. These could easily be counter-balanced by other customers to whom you give discounts for cash on delivery, or other prompt payment terms, such as within seven or fourteen days of invoice. It is the overall balance that is important to achieve.
In any period of expansion, it is also important to have a clearly defined credit control policy. Without going into great detail about credit control activity and debt collection techniques, it is necessary for the sales or accounts staff (or whoever deals with outstanding debts) to have clear guidelines to follow. These might include:
Specified credit limits for each customer, which they cannot exceed without either payment or the owner-manager’s specific authority.
Specified dates or points at which the various credit control activities are triggered, for example initial reminder telephone calls, reminder letters, warning letters, supplies stopped, legal action commenced, etc. Once established, these should be adhered to firmly. Simply monitoring the aged debtors analysis generated by the accounting system at the end of each month is insufficient, there needs to be a designated person in the business who has the specific responsibility of monitoring payments due, on a daily basis.
Clearly defined responsibilities for debt recovery and customer liaison. There is nothing worse than one person in the business chasing a customer for late payment, whilst the salesman is on the premises trying to get further orders. This happens frequently, and particularly in smaller firms where the financial and customer information systems are less likely to be fully integrated.
Good working systems to ensure that the creditors of the business are paid on time, to ensure the maintenance of the supply chain, and to avoid the embarrassment of unavailable stock when your supplier will not deliver until your cheque is cleared.
A contingency plan in case of emergencies, e.g. seasonal disruption of trade through bad weather. This is where the budgetary plan and cash flow forecast can help identify potential problems, and where, for example, temporary overdraft facilities can be arranged well in advance in readiness for any problems. Apart from the arrangement fee, an overdraft only incurs charges if and when it is used, although the fact that it is available should not tempt you to use it unless it is really required.