Effective credit risk management - the three Cs

When you go into business you take on a certain level of risk. You add to that level of risk when you extend credit to new customers however, extending credit is an important part of growing your business. That's why it's important you know what to look out for before you allow a customer to establish a credit account.

The three Cs of credit risk management provide a good guide for SMEs who are looking to offer products and services on credit.

1. Conduct credit checks

Before you embark on a long-term relationship with a customer, you should consider running a credit check to gain a thorough understanding of who you will be dealing with - this is the best way to assess their ability to pay.

A credit check can be conducted through a credit reporting agency and it can confirm a business' existence or identity, predict financial stability and payment patterns, and provide valuable information on legal or bankruptcy records. In particular, you should examine a potential customer's trading record, connections with any companies that have failed and previous directorships to determine if executives have been on the board of failed companies.

Getting a sense of the character of the business and its key decision makers are critical in assessing a company's ability to meet its financial obligations.

2. Consider your terms

Longer credit terms mean you're not getting paid for longer, so it's essential to periodically review your terms and evaluate if you need to shorten them. Your credit terms should be based on the level of available cash reserves and risk appetite - for instance, if you are offering 45 day terms, you should have enough funds to pay your staff, overheads and other expenses. You should also be confident in your customers' ability to repay their accounts.

However, SMEs generally don't have large cash reserves - so it might be a good idea to stick to the standard 30 day terms or even reduce this to 14 or seven days depending on how much you sell. Alternatively, you can arrange a payment plan with your customers whereby they pay over several installments or provide an upfront payment.

3. Collect overdue accounts

If you have a credit policy in place, it's likely you also have a procedure to collect overdue accounts, which makes up a crucial component of the accounts receivables process. A failure to recover outstanding amounts will result in write-offs and accumulation of bad debts, which means you will have to generate more sales to make up for these losses. Having a contingency plan will help prevent these outcomes, and this can be as simple as sending reminders for amounts that are a couple of days to a week late, and escalating this process as necessary. If there is still no response and the invoice is more than 60 days overdue, you may want to refer the matter to a debt collection agency.

Cash is king. Implementing the above strategies can help you to manage your credit risk and ensure the ongoing financial health of your business.

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