Written by Govindraj
Muthyalu CPA, CIA, CISA
One of our major customers, a consumer electronics
distributor who had huge receivables from a well-known retailer, told me “IF I STOP SUPPLIES, THEY WILL STOP PAYMENT, AND START BUYING FROM MY COMPETITOR”. It was a catch 22 situation. The retailer in question was a reputed company
which had many branches across the country.
The distributor had offered 30 days credit to the retailer. Within 15
days after the first order, the retailer had placed another big order. After 30
days when it was time to pay the overdue invoices relating to the first order, the
retailer placed one more order and requested for additional time to pay the
overdue invoices. The distributor was
comfortable in extending additional credit since he was getting sizeable orders,
and he did not anticipate any issues with the payment from the retailer. As weeks and months passed by, the supplies to
retailer increased at a much faster pace than the increase in the payment from
retailer. Whenever the distributor used
to ask the retailer to clear the overdue invoices to get new supplies, the
retailer used to clear small part of the overdue invoices and request for additional
supplies. The retailer had excellent business
but was poor in paying his suppliers. The retailer used to tell the distributor
not to force him to go to other distributors by stopping the supplies. It was a
“SOFT EXTORTION”. In about a year, before
the distributor could realize, HIS HUGE
RECEIVABLES FROM THE RETAILER HAD BECOME HIS LIABILITY.
I am sure many of you, who had offered credit without due
diligence and proper documentation, must have faced a similar situation. Here
are the 5 ways by which you can avoid your receivables from becoming your
liability.
Proper Credit
Documentation
Never ever offer credit to any customer without proper due
diligence, and before signing and completing the credit related
documentation. Many a times, small businesses,
in their eagerness to get associated with big brands and customers, tend to
either overlook or ignore this very important step before offering credit.
Get Post Dated Cheques
Wherever possible, negotiate with the customers and offer
them credit against Post Dated Cheque (PDCs).
For example, if you are offering 30 days credit, get a cheque which is
dated 30 days from the date of invoice at the time of delivery of goods. In many countries, bouncing a cheque is a
criminal offence and hence businesses may be reluctant to issue PDCs unless
they are sure of honoring it. If
customers are reluctant to issue PDCs for supplies within the credit limit,
then insist on a PDC for supplies over and above the credit limit.
Get a Revolving LC
or a Bank Guarantee
Ask the customer to open a Revolving Letter of Credit (LC) or
give a bank guarantee against credit supplier. Most of the big businesses will
have bank facilities and they should be able to provide you one of these. You
can negotiate and share the bank charges with the customer.
If a customer is not willing to provide a PDC or LC or guarantee,
then be careful with such customer. If people have intention to pay on time,
they should not hesitate to provide PDCs, LCs or bank guarantees.
Take credit
insurance
Another good way of protecting your company against failure
of your customers to pay your debts is to take credit insurance against your
major customers. Even though credit insurance comes at a small cost, it will
help you to increase your sales by offering credit to the credit insured
customers, since you are assured of payment by the credit insurer in case the customer
defaults. Look for a credit insurer who has
coverage across cities and countries wherever you have customers. It is extremely important to evaluate and
negotiate the terms and conditions of various credit insurance companies before
finalizing one of them. In one of my earlier companies, I used to deal with
“Euler Hermes”, which is the world’s number 1 credit insurance company that has
coverage across major cities in the world.
Don’t be afraid to say NO to a credit sale if
you are not comfortable
It is
very important to know when to say NO to a credit sale. Even though Sale is the life blood of business, if the customer is not regular in
payment, if his receivables has crossed the credit limit, or if there are
several unpaid overdue invoices, do not offer additional credit to the customer
without securing the existing receivables. Credit department should have a
mechanism to get the credit rating / standing of all their customers from the market,
and reevaluate on a regular basis whether to continue to offer credit to
customers.
About the Author
Govindraj
is a CPA, CIA, CISA and has more than 25 years of finance, accounting, auditing,
and IT experience. He has worked as a controller and a CFO of many
multi-million dollar companies. He is a Gold Winner under the
category "Executive of the Year - Computer Software" at International
Business Awards 2016 held at Rome, Italy, and a Bronze Winner under
the category "Executive of the Year - Cloud Computing / SaaS /
Internet" at Golden Bridge Awards 2016 held at San
Francisco. He has lot of experience in designing systems /
processes, and implementing ERP packages in various industries. He is the
CEO of Cashpundit Inc. (www.cashpundit.com), a startup that he
founded to help businesses to manage their collections and cash flows.
