Customer credit risk management
Default arising from customer credit risk is inherently guaranteed in all industries, however taking certain steps can minimize this risk. You are likely to face bankruptcy clients or slow payers who can drain your cash; especially if it has a substantial cost associated with serving that same customer. Keeping the days to sell (DOS) ratio as low as possible will mean your business always has adequate funds to keep operations going.
The DOS ratio simply measures your ability to convert accounts receivable to cash. The lower the ratio, the faster you will get cash at the door. On the other hand, a high DOS ratio means that your company has a higher risk of customer default on its debt. First, refrain from automatically granting credit to each customer on the account. Establish a strict, effective and adaptable credit policy. The first line of defense is the Credit Application, which must be a robust and rigorous process.
Each customer credit approval process should include credit references from existing vendors the customer has, recent financial statements, recent tax return, as well as included language on late fees and finance charges. In addition, you must detail the amount of credit that is approved for the client and the payment conditions. A common mistake companies make is that they allow a customer to buy beyond their approved credit amount, this is a mistake as it undermines the entire credit application approval process, plus your customer will now not take the loan seriously. amount of your credit limit.
As a business owner, you need to understand when it’s time to cut your losses, sell more, or continue serving a delinquent customer doesn’t increase your chances of collecting overdue bills, it just plunges you further into the hole. A concerted effort is required to collect outstanding invoices. One of the best methods that always worked for me is to analyze the outstanding accounts receivable on a weekly basis, as well as keep in constant communication with each of my clients about where their balances were, as well as determine the expected date of payment.
Maintaining constant communication with your customer is crucial, as this will signal to your customer that you are keeping an eye on their accounts receivable. However, not maintaining constant communication with your customers indicates that you are in no rush to collect outstanding invoices. Offering discounts for early payment or charging late fees is a good way to encourage a customer to pay their bill before the due date. The common discounts that are given are 2% / 10, which essentially means that you will give a customer a 2% discount on an outstanding invoice, only if it is paid within 10 days of the invoice date.