Customer credit risk management
Default arising from customer credit risk is inherently guaranteed in all industries, but taking certain steps can minimize this risk. You are bound to run into clients who either file for bankruptcy or are slow payers that can drain your cash; especially if you have significant costs associated with servicing the same customer. Keeping your days sales outstanding (DOS) ratio as low as possible will ensure that your business will always have adequate funds to support operations.
The DOS ratio simply measures your ability to convert receivables into cash. The lower the odds, the faster you get cash. On the other hand, a high DOS ratio means that your business has a higher risk of customer default. Above all, refrain from automatically granting any customer credit on account. Create a strict credit policy that is both efficient and adaptable. The first line of defense is the credit application, which should be a robust and rigorous process.
Any customer credit approval process should include credit references from existing vendors the customer has, recent financial statements, a recent tax return, as well as included language regarding late fees and finance charges. It should also state the amount of credit the customer is approved for and the terms of payment. A common mistake that companies make is to allow a customer to buy more than the approved amount of credit, this is a mistake as it undermines the entire credit application approval process, also now your customer will not take your credit amount seriously limit.
As a business owner, you need to know when it’s time to cut your losses, selling more or continuing to provide services to a delinquent customer doesn’t increase your chances of collecting already delinquent invoices, it only puts you deeper in the hole. A concerted effort must be made to collect unpaid invoices. One of the best methods that has always worked for me is to analyze outstanding receivables weekly as well as keep in constant communication with each of my clients about where their balances are as well as establishing the expected payment date.
Maintaining constant communication with the customer is crucial as this will signal to the customer that you are keeping an eye on their accounts receivable. However, not maintaining constant communication with your customers signals that you are in no rush to collect unpaid invoices. Giving discounts for early payment or charging late fees is a good way to encourage the customer to pay their invoice early and before the due date. Often the discounts given are 2%/10, which basically means you will give a customer a 2% discount on an unpaid invoice only if it is paid within 10 days of the invoice date.
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