Nine credit management rules for small businesses and entrepreneurs
Businesses generally fail because they run out of cash, and one reason for running out of cash is that customers are not paying you when they should. Credit management is part of cashflow management. Cashflow is something that I am much more aware of as a small business owner than I was as a lawyer or corporate credit manager.
Perhaps the most valuable credit management tip that I have applied to my own business came from a very shrewd Californian credit manager I once interviewed while researching a book. He said that one of the most important things he looked for when he was evaluating a customer’s creditworthiness was the customer’s foresight in using his or her assets to establish lines of credit. It’s related to the unfortunate tendency of banks to favour lending to those who don’t really need the money.
"Let’s say the business owns its own building," he suggested, "and hasn’t borrowed against it. Then times get bad and it runs out of cash; it can’t immediately turn the building into cash by selling it; if it goes to the bank and tries to use it as collateral the bank turns it down because the cashflow is poor. It needs to have set that up when times are good, not after they have turned bad." Of course, having an overdraft you don’t need costs you money, but for many businesses it is a very sensible precaution. The common option for many small businesses nowadays is to have a "flexible" mortgage (make sure you have scope to extend it as far as the value of the house allows).
I took this to heart, arranged my maximum line of credit with the bank when things were good, and sailed through a tougher period of trading with plenty to spare. His advice ties in with research that says that, from a creditor’s perspective, one of the better signs that a business will not fail is the fact that it has an overdraft but doesn’t use it.
Here are nine credit management tips for small businesses and entrepreneurs.
1. Treat credit management as an important aspect of your business
It’s a truism to say that much of the success of any business comes down to the mundane. It’s not enough to just be able to sell your bright idea or your product. You have to process the orders and produce invoices, put the letters in the envelopes, buy the stamps, pay the bills, keep the windows clean and the floor vacuumed, buy milk and sugar and coffee, ...and do the credit management. Ignore it at your peril.
2. (Almost) always credit check
It’s tempting to say that any new credit account needs forms filled in and a credit check done. However, there are exceptions. If your account is for a one-off purchase of $20 you don’t want to spend $5 on a credit check. If your customer is Telecom, or your brother-in-law, you probably feel you know more about them than a credit check could tell you. But even, or perhaps especially in those cases, you need documentation. For any new account, you absolutely need to know who you are dealing with.
3. Avoid giving credit if you can
If you’re giving credit for $20 as in our previous example, why are you doing it? Why not take a credit card or simply insist on cash? Even if you must give credit, you don’t have to give the customer until the 20th of next month to pay. If, at the start of the transaction, you set and emphasise other terms (say 7 day terms) people will generally accept them and often keep to them. (If you don’t stress it up front, it won’t work.)
4. Avoid doing business with people you don’t trust
This sounds obvious, but the dollar signs overwhelm our good sense in many cases. The bigger the deal, the more important it is that you are dealing with honourable people. It’s particularly important in partnerships and business alliances and the latter are more and more common these days. No matter how good the deal looks, try not to get involved with dishonest people.
5. Don’t overlook the wider billing process
Many businesses recognise that they have a credit management problem, and try to do something about it. Maybe they send their people to a seminar. That’s good as far as it goes, but what we know is that the real problems sometimes lie further back. Credit is part of a process that for most businesses includes producing invoices, sending them out, and dealing with disputes. Don’t overlook these other aspects. For many businesses, their bad debts are far lower than their losses from bills they never get round to sending.
6. Credit management is about regular systems.
For many small business owners, credit management is not the favourite job. It can be stressful, there can be conflict, and you can lose customers. So they put it off. We say, "procrastinate about vacuuming by all means, but not about calling overdue customers." In credit management, time is of the essence.
One way to cope with the mundane is systems. Credit management is a regular task. Most businesses work on a monthly cycle. You send out your statements on a certain day; you follow up on unpaid accounts x days later; and you stop credit on those who still haven’t paid a certain number of days after that. Systems make life easier.
7. Call unpaid accounts as soon as possible
This is one of the keys of good credit management - the nearest thing to a silver bullet we can offer. The creditor who calls his customers 5 days after the account was due will, other things being equal, have a better accounts receivable ledger than someone who waits 30 days. Both will do better than the person who only writes letters to overdue customers.
8. Think about employing credit staff
As an entrepreneurial small business owner you either employ people to do the credit management for you or you do it yourself. If you don’t have time to do it properly yourself, get someone else to make those calls (and do it properly). And especially if you are also your business’s main sales-person. It’s not impossible for sales-people to also carry out a credit function, but it’s hard. Selling depends in part on customers liking you personally. It’s harder for customers to like someone who puts the acid on for payment.
9. It’s all in the detail
Have you ever had to search on an invoice or statement to find the date you’re supposed to pay it or the address to send it to? For some people, that will be enough to make them give up on that invoice and pay the next one instead. Little things make a difference in credit management.
The best credit operations and the best credit staff don’t do things much differently from the average. (Aside from early phone calls, there are no miracle techniques.) They just do lots of things 1% or 5% better. They make a few more calls every day, are a little bit more persuasive, a little bit better at getting people to put the cheque in the mail when they’ve said they would, and so on. But we know, because we’ve seen the figures, that one excellent credit controller will achieve better results than two or even three people who are only average.
Peter Hattaway is a director of Hattaway & Associates Ltd, Credit Consultants. He can be contacted at peter@hattaways.com and welcomes your queries.