RECEIVABLE MANAGEMENT AND CREDIT CONTROL
Trading and manufacturing businesses invest considerable amounts in purchasing inventory, adding value into it and then earn profit by selling this inventory. Similarly, businesses engaged in provision of services also incur certain expenses like salary to staff and office rent etc. so they can provide services to their clients and earn revenues.
Some products and services are sold on cash, however a significant amount of sales is made by allowing customers a reasonable credit period. Customers during the allowed credit period payback the cash against the goods or services purchased. This cash is again reinvested to purchase inventories and meet expenses to carry on business activities. This cycle of investment of cash to generate more revenues/ cash is called the cash cycle.
In the above described cash cycle, if a customer delays while paying back, business has to invest further amounts to continue business activities smoothly.
Credit Control
New businesses/ startups usually offer lucrative credit terms to attract customers, however extensive delay in payments by the customers may widen the company’s cash cycle and business may end up with dried cash reserves.
Even the well established business may face cash shortages if receivables are not managed properly.
Businesses involved in making sales on credit and especially startups shall monitor their receivables and ensure proper credit control, so cash shortage can be avoided. Insufficient credit management and receivable monitoring may result in longstanding and toxic receivables and cause acute cash shortage.
For effective credit control/ management, following points shall be considered;
- Assign a Credit Limit to each debtor based on its credit worthiness. Credit Worthiness of a customer can be assessed based on factors including Financial Health of the business, sponsors/ owners profile and market reputation, previous credit history etc. The services from the credit agencies can also be hired to assess the credit worthiness of a customer.
- Send a monthly Statement of Account (SoA) to your debtors. This statement shall contain;
- Opening balance at start of the month
- Sales made to the customer
- Payments received to the customer
- Any adjustment (Credit/ Debit Memo, returns etc) made during the period.
- Closing balance at the end of the Month.
Request the customer to reconcile this statement with their record. Sending SoA will minimize the chances of any confusion and work as a reminder to the debtors of how much they owe you.
- If a customer defaults on its payment and does not pay by the due date, stop providing further goods on credit even if they have not yet crossed the assigned credit limits. Resume supply of the goods/ services only after the assurance from the designated person regarding payment of all outstanding due by the due date in the future.
- Ask for a referral from new customers. In case of default and nonpayment by the customer, try to reach out the referral with the request to ask the customer for payment of all outstanding dues.
- Depending upon the popularity and market position of the business, customers asking for a credit period for the sales on credit, can be asked for provision of collateral against the goods/ services sold to them on credit. This collateral may include provision of a bank guarantee from a reputable bank or deposition of cash security deposit. The amount of such collateral shall not be less than the credit limit being assigned to the customer.
- If the customer defaults and does not pay even after several reminders, consider filing a recovery suit against the customer.
Factoring
Factoring is a service provided to the business for collecting cash from receivables and managing other credit control activities. Factoring agencies employ professionals having expertise in cash collection and credit control and management.
Businesses try to maintain their liquidity at optimal levels so the vital expenses can be paid and transactions can be processed smoothly. The maintenance of liquidity becomes more important when a business is in its early stages and has a shortage of cash and other financial resources. On the other hand, it is common to offer a credit period to retain existing and acquire new customers.
Factoring agencies provide services for cash collection from debtors and other similar credit management services in return for a fee. Such firms also provide loans against the receivable amount of a business. Agencies provide advance/ loan equal to the amount of receivable and then all the cash collected from debtors is deposited into the agency’s account instead of a business account. Factoring agencies charge a fee against their services and earn interest by providing loans/ advances to the business.
Businesses facing the difficulties in managing its receivables and timely collection of cash from its debtors often hire the services of Factoring agencies, which help the companies to manage its cash flow and working capital effectively.
