Most businesses trade on credit terms with their customers, letting them purchase as they need and pay later.
This can be a great way for businesses to build their customer base and gain more work or sales, since customers will often buy more if they don’t have to pay immediately.
However, extending credit to customers, while a common and strategic business practice, also comes with risks, so it’s important business leaders protect their organisation accordingly.
“One of the biggest problems with a line of credit is that it can affect the organisation’s cash flow,” said Mark Hoppe, managing director, Oceania, Atradius.
“A healthy cash flow is more than just a sign of a healthy business, it can be a make-or-break factor. A stable cash flow lets businesses pay staff, buy materials, and meet their debt obligations.”
When deciding to extend credit to their customers, business leaders need to arrange regular payments with customers to keep cash coming in. It’s also essential to conduct due diligence regarding customers, including comprehensive credit checks, to ensure the organisation is not taking on bad debt.
For new customers, business leaders may decide to set payment terms of 30 days to establish if there will be problems with the payment. Older, more established customers may have 60-day or even 90-day payment terms. This should be an earned privilege rather than an automatic right for all customers.
When an organisation has substantial amounts of working capital tied up in accounts receivable, or the bills as-yet unpaid by line-of-credit customers, the business faces a significant risk if customers don’t pay on time.
There are three key ways businesses can extend credit to customers without facing undue risk:
1. Be choosy
It’s safer to work with customers that can demonstrate a strong credit history and on-time payment track record. A company promising a large order but with no visible means of paying could present a huge risk that isn’t worth the potential reward. By contrast, customers with a more conservative ordering approach who are known to pay on time are more likely to benefit the business in the long term.
2. Be timely
To encourage customers to pay on time, it’s important to invoice them in a timely manner and make payment terms clear, whether it’s 30 days or longer. If payments are late, business leaders should then chase them up in a timely manner to set the expectation that late payments won’t be tolerated. If necessary, organisations may need to instigate collections proceedings to ensure they receive payment.
3. Be protected
Trade credit insurance can protect the business against losses, covering the shortfall when customers don’t pay. This protects the business’s cashflow. However, a trade credit insurance provider can do more than that. They can also provide assistance with due diligence and credit checks to ensure a line of credit is only extended to trustworthy customers. They can provide debt collection services if customers don’t pay and they can provide market assessments that help business leaders understand the risks and opportunities in their sector so they can make smarter decisions.
“Credit insurance policies cover goods and services sold and delivered, and can be tailored to cover many risks, like work in progress and binding contracts,” said Mr Hoppe. “This means that even smaller businesses that operate on lean budgets and profit margins can continue to do business with the assurance that they will be covered if their customers don’t or can’t pay outstanding invoices.
“In such an event, trade credit insurance can often step in and provide the capital for an organisation to keep operating without needing to opt for comparatively risky options such as extending credit or overdrawing accounts and eating into what might be a meagre buffer zone.”