Businesses across sectors are currently coming under significant financial pressure. Factors such as rising energy prices, supply issues and wage inflation are causing costs to creep up, meaning that decision makers may need to increase prices for their goods and services. This will stave off financial difficulties by protecting cashflow and allowing working capital to be effectively managed in connection with good credit management.
The purpose of credit management is to grant credit and manage credit lines efficiently, in order to optimise the business’ cash position. One of the key challenges to keeping on top of a debtor’s ledger is that often, business owners are afraid of damaging long-term customer relationships. For this reason, it’s important to strike a balance between allowing customers some flexibility and setting boundaries.
Carrots and sticks
When thinking about the best way to encourage customers to pay on time, it’s helpful to remember the ‘carrot and stick’ approaches. A good example of the ‘carrot’ approach would be a scenario where the business makes it as easy as possible for the customer to make a payment on time, for example, ensuring that exactly the right amount has been invoiced, the correct corresponding delivery notes are available, and they correspond to the correct purchase orders raised.
Decision makers may also want to consider incentivising businesses to be good customers by providing a discount for prompt payment. However, controls must be put in place and care taken to ensure this approach works for the business. For example, decision makers will need to check that late payments don’t lead to an automatic reduction and rather than offering repeated discounts, it may be worth considering one-off incentives instead.
Timing is also an important consideration. For example, an invoice is much more likely to slip down the customer’s list of priorities if it arrives at 4pm on a Friday. Sending it at the same time each month also helps customers to know where they stand, assisting them with their cashflow planning.
On the other hand, examples of the ‘stick’ approach to credit management are last resort measures, such as appointing a debt collector, or petitioning for a company to be wound up. While there is a time and a place for this kind of action, it’s worth remembering that these are short-term solutions and are more likely to damage valuable customer relationships.
The nature of the human psyche means that people will often try to push boundaries, if allowed. As the customer’s priority is to manage their own cashflow, they may look to exceed their payment terms if possible. As such, it’s important to set a precedent by consistently requiring customers to pay on time and using the stick approach to reset boundaries if payments start to slip. The business can also set a positive example by paying its own suppliers on time and promoting its reputation as a good customer.
A useful strategy for businesses managing their credit lines without negatively impacting customer relationships is to separate responsibilities; chasing payments should sit solely with the credit manager, while the client manager focuses on strengthening the client relationship.
Good and bad customers
Decision makers also need to appreciate the difference between good and bad customers and know when to take tough decisions. From a cashflow perspective, there’s little value in having a profitable customer on the business’ books if they fail to make payments on time. In this case, the business may be spending significant amounts of time and resource chasing payment, which might be better invested in new business activities.
Companies should also avoid putting all their eggs into one basket. Even if a customer is well-known or places a lot of business, it’s likely that cashflow would take a hit if they stopped paying. Often, a clear sign of a good customer is how open and transparent they are when it comes to communicating with their suppliers. Good customers are more likely to keep the supplier updated when they’re going through tough times, so the business can plan accordingly. For example, communicating that they won’t be able to pay at the 30-day mark, rather than waiting to be chased, enables the business to build extra time into its cashflow cycle.
In the current climate, business owners need to focus on maintaining a healthy cashflow and can’t afford to let customer payments slip. By carefully considering how best to incentivise prompt payments and setting clear boundaries, good credit management doesn’t have to come at the expense of valuable long-term customer relationships.