Effective Credit Management – Part 1

By Mark Logue, joint Managing Director, AMPAC Debt Recovery

This article discusses the importance of credit risk management for all businesses that provide trade credit. Here we discuss the cost of bad debts, the correct approach to opening a new account and the role of a collection agency in recovering overdue debts.

A businesses’ accounts receivable is often one of its largest assets and provides the cash-flow necessary to prosper and grow in these challenging and changing times. Quality credit management is a key element of strong cash flow. If practiced correctly, it will support the company’s cash flow requirements and contribute to growth and profitability by minimising the incidence of overdue accounts and bad debts.

The key elements of quality credit management revolve around:

• Credit documentation;
• Account set-up and maintenance;
• Verification of customer information;
• Overdue account procedures.

We will outline a quality approach to credit risk management which can be adapted to suit the specific requirements of almost any business, particularly those in the SME market.

Whenever an organisation provides credit, there is a risk the account may not be paid on time. In addition, the longer a debt remains outstanding, the likelihood of it never being paid increases. Quality credit management is a combination of good internal procedures, quality documentation and swift, decisive action.

Below is a table which identifies the cost to business of writing off bad debts and illustrates the additional sales revenue required to offset a bad debt. As can be seen, if a business generates a profit of 10% and suffers a bad debt of $10,000, it will need to increase sales by $100,000 to negate the effect of the bad debt. What is not represented here is the indirect costs associated with carrying the bad debt. These indirect costs include the cost of replacement capital, the labour costs associated with chasing the debt and the opportunities lost as a result of diverting labour to chase overdue accounts.

The Impact of Bad Debts on Sales

Loss               Net Profit Percentage   2% 3% 4% 5% 6% 8% 10% $1,000 $50,000 $33,300 $25,000 $20,000 $16,660 $12,500 $10,000 $5,000 $250,000 $166,667 $125,000 $100,000 $83,333 $62,500 $50,000 $10,000 $500,000 $333,333 $250,000 $200,000 $166,667 $125,000 $100,000 $15,000 $750,000 $500,000 $375,000 $300,000 $250,000 $187,500 $150,000 $20,000 $1,000,000 $666,667 $500,000 $400,000 $333,333 $250,000 $200,000 $50,000 $2,500,000 $1,666,667 $1,250,000 $1,000,000 $833,333 $625,000 $500,000

The good news however is it is not expensive to improve the management of credit. An investment of time and a commitment to implementing quality practices, procedures and documentation will pay handsome dividends almost immediately.

The Role of a Debt Collection Agency

A key part of a good credit policy involves selecting the right partners to assist you along the way. This includes your choice of collection agency. Generally, the services of a collection agency will include:

• Recommending the most appropriate and cost effective debt recovery strategy for each matter;
• Issuing written and telephone demands for payment;
• Locating debtors and conducting field calls when required;
• Handling inbound debtor queries resulting from the demand process;
• Establishing and managing both formal and informal debtor payment arrangements;
• Commencing legal action and carrying out enforcement when necessary;
• Identification of debtor assets;
• Reporting on the performance of individual matters as well as the overall portfolio;
• Liaising with field agents, process servers, solicitors and the Courts;
• Carrying out searches of company and property registers; and
• Assisting clients to improve their terms of trade where appropriate.

Note: The introduction of the Personal Property Securities Act 2009 (PPSA) in 2012 has meant many organisations have had to update their terms and conditions of trade to allow them to register their Security Interest in property, goods or equipment. The registration of a Security Interest replaces an organisation’s previous ability to retain title over goods by including a Retention of Title Clause in their terms and conditions.

Opening a New Credit Account

One of the most important aspects of credit management occurs at the beginning of the business relationship. The quality and accuracy of information obtained prior to extending credit often determines how successful an organisation will be at recovering its debt.

The account set-up procedure should include a checklist to ensure each new account is established consistently and all paperwork and account verification procedures are followed. The purpose of developing a structured approach to opening new accounts is to filter high-risk debtors and reduce that risk and at the same time, identify quality customers with whom sales opportunities can be optimised.

As a minimum, the following processes should be introduced:

• A credit application must be completed, signed and returned by the prospective client. If information you request is not supplied, the account shouldn’t be opened until all the information is provided. The Accounts Receivable Officer should contact the new customer by telephone in order to obtain any missing information, following which, the verification process can commence.
• The legal structure of each new entity should be verified before the account is opened. Correct identification of an organisations legal name, ACN and/or ABN will save time and money down the track if an account becomes overdue. If information obtained from the client varies from the information in the credit reporting database, this should be clarified with the client before opening the new account.
• Check the company name and ACN with ASIC, to ensure it is incorporated and the details supplied are correct. Also do an ABN search on the company name and if you find the ABN’s last nine numbers are completely different from the ACN, then you have identified the entity is in fact a trustee company and should be set up that way in our system.
• Consider conducting a credit check to identify adverse information such as reportable court actions and payment defaults.
• If trade references are obtained, they should be checked to verify the customer’s capacity and willingness to pay.
• As soon as all the required information is obtained and verified, the new account is ready to opened.

As a supplier, you should never feel pressured into opening a new account until you are satisfied the prospective customer is worthy of your credit.

Finally, keep credit on the agenda at management meetings. Discuss major accounts regularly, as well as the slow payers. Encourage everyone to be on the lookout for warning signs a business is struggling and act swiftly and decisively if problems are identified.

Mark Logue is a debt collection specialist and the joint managing director of AMPAC Debt Recovery. He has more than 30 years experience in the debt recovery and credit reporting sector, covering all segments of industry and commerce throughout Australia and overseas. Contact: 0409 749 709 or: m.logue@4ampac.com.au