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By Abbas Ali (CPA, CSA, CISA)

“Cash is king” An old saying that has gained popularity in the years following the global financial crises.

A common observation of today’s industry shows that most failed businesses attribute their failure to cash flow problems. Cash flow is a paramount consideration for any business, especially one that’s still in its first couple of years of operation and many businesses fail simply because they run out of cash during this period. Successful businesses require consistent cash flow for ongoing operations and additional cash reserves to fund growth opportunities.

One of the consequences of bad credit management is the squeeze on working capital due to delay in repayment to a write-off that comes straight off the bottom line profits. The real benefits of sound credit risk management practices gets more visible during periods of economic downturn which strains the economy from credit. For example; the oil prices drop in 1986 – 1987 that hit the region hard, and more recently the global financial crises of 2008.

A business owner may prefer to have a strict up-front payment or on-delivery payment policy but the realities of a competitive business environment are such that, in order to be competitive, you may have limited options. Most customers will simply pay you when due. Others, unfortunately, will not.

It is useful for the business owner to perform an overall diagnosis of the business, people and processes to assess the organization’s collection strengths and weaknesses and apply a sound credit management team to mitigate these risks.

Risk control involves taking measures to minimize the possibility of the risk occurring and/or to minimize the effects of the risk in case such an event actually occurs. For credit, risk control can be achieved by establishing a sound credit risk management. Key elements of a good credit risk management include:

• Having a clear credit policy and credit process
The larger the receivables portfolio, the more rigorous the policy would be. The policy should include guidance as who gets credit and who doesn’t, and the possibility and need to establish proper controlled Limit Allocations to Customers. The policy would be a guidance on deciding on customer’s character, reputation and credit checking, and overall financial capacity (ability to pay). Nevertheless always, consider that exceptions could happen throughout the process, keep it minimal and controlled.

• Clearly define applicable payment methods and terms
Consider prepayments, partial down payment incentive for early payments etc. and have a clear payment schedule in place for all contracts that best suits the business model. If at all, build in the cost of financing this element of working capital in your pricing.

Assign accountability/empowerment for speedy resolution and action
For example, would collection rest with the salesman with an incentive closely tied to collection effort, employ dedicated collector or a full-fledged credit control department.

• Ensure proper alignment of incentives
Always ensure proper alignment of incentives with collection as they are the key in attracting and retaining the best collectors. The program should be simple to understand and easy for collectors to quickly receive rewards yet should be drawn after a careful consideration of the level and frequency of compensation, team vs. and /or individual goals, including support staff.

• Collateralize your receivables
Always collateralize your receivables as practically as possible including guarantees and letters of credit, from acceptable Banks and third parties etc.

• Using a CRM system
To help manage receivables can be a very effective way to target potential tardy clients by remaining active in the collection process.

• Have a robust collection and escalation mechanism
Use standard benchmarks such DSO or aging buckets. Consider customer segmentation for ease and efficiency of reviews. To properly monitor receivables, one should set aside time each week to review and take action on outstanding accounts. Remain courteous and polite but start pushing for a resolution. For example; if the person you’re dealing with says they need to make enquiries and will get back to you, establish a time to call back and follow through. Proper remedial management should be put in place (i.e. classification of delinquent accounts).

• Be close to your customers
As much as it sounds simple, it could save you a lot of time and unnecessary effort.

• Vigorously follow up to recover over dues
Don’t be afraid from losing business from a customer that does not have the intention to pay:

  • You may choose to seek the help of a debt collection agency who will take over the recovery. For a percentage of debt collected, these agencies built an extensive experience and expertise that could save you the hustle of daunting job.
  • Retain a lawyer and request him to send a strongly worded letter demanding payment and the consequences of non-payment.
  • You may directly seek to file a court case. Understand the regulatory environment and ensure that your debt is not in dispute. Always maintain sufficient documentation to build a solid case.

Although specific credit risk management practices may differ among organizations, depending upon the nature and complexity of their credit activities, effective Credit Risk Management is a critical component and essential to the long-term success of any organization.