Credit management – A sale is a gift until it’s paid for (part 3)
If your business model doesn’t allow you to be paid upfront…….…..read on.
Successful credit management should be front and centre for all businesses, irrespective of the wider economic circumstances. We’re still coping with a massive contraction of credit across the world which makes your own credit management much more important.
These blogs set out a comprehensive framework for credit management which will help you to lower your risk and put more money in your bank.
Measuring credit management performance
The most-used performance tool is the Aged Debtors report, which lists all of your customers with outstanding debts and breaks them down by age.
It’s vital that this report has the biggest balance at the top and the smallest at the bottom (rather than being an alphabetical list) so you can concentrate on the largest balances first.
Don’t overlook any customers at the bottom of the list who have negative balances – this can mean you owe them money or that an invoice, credit note or some cash has been allocated to the wrong account. Whatever the problem, try to correct it quickly.
You can use this report to establish targets for credit control, such as a maximum value or % of the total for each column. For example:
- Debtors over 60 days old should not exceed £20,000 or 10% of the total
- Debtors over 90 days old should not exceed £10,000 or 5% of the total
Try to stop the balances in the 61-90 day column moving into the >90 column next month.
Cash collection targets
Another very simple target is the amount of cash collected each month. You can have a minimum collection level and then consider paying bonuses to your credit management team for beating the basic target.
Debtor days ratio
This ratio looks at the average sales you make per day and asks how many days’ sales are built up as unpaid debts.
There are several different ways of calculating the ratio and the key is to be consistent. Here is an example:
Annual sales (including VAT) are £2.5m. Therefore, average daily sales are:
£2,500,000 / 365 = £6,850.
Debtors are £400,000.
Debtor days are:
400,000 / 6,850 = 58 days
This means that you have 58 days of sales tied up in debtors at the moment.
The aim is to reduce debtor days, hopefully as sales increase.
Other credit management tools
It’s possible to insure your business for the risk of not being paid by a client.
You pay a premium and the credit insurer will give you credit limits for each client, or a group of clients, and provided you stay within the credit limit the insurance policy will compensate you if the client goes under.
Under a factoring arrangement, you effectively sell your unpaid sales invoices to the factoring company (usually a bank). They pay you, say, 80% of the value of the debts upfront, they are responsible for credit control and, once they have collected the money from your client they will pass on the balance, less their charges (which can be high!).
The factoring company will also charge you interest on the money they lend you.
Cash accounting for VAT
You can adopt “cash accounting” for VAT, provided your annual sales are below £1.35m and several other requirements are met.
Under cash accounting you only pay over VAT on your sales invoices which have been paid in the quarter and you can only reclaim the VAT on bills you have actually paid.
Most PC-based accounting systems will let you do this and, although it doesn’t improve credit control, it can help with the cashflow effects of money being collected more slowly than you would like.
Credit management is too important to be left to take care of itself. By using some of the tools in these blogs you can reduce risk and increase your bank balance, leaving you more time to concentrate on the future instead of the past.
At Blue Dot Consulting we have a lot of practical experience in credit management and control and would be pleased to help your business if you have credit management issues to be resolved.