This article has appeared in the newsletter before - back in September 2008 when we were in the throws of the so called credit crunch. Speaking to a contact of mine recently, who is an insolvency practitioner, he told that his practice is expecting an increase in insolvencies this year. So now is a good time to remind ourselves of the importance of good financial management.
Any business adviser would be able to tell you numerous stories of seemingly successful business going bust or running into serious financial trouble. The order book can be healthy and the forecast for profitability good, but in the short-term the company simply runs out of cash, they find they can't pay the bills as they fall due and then the trouble starts.
But how do they get into this position in the first place?
- A major customer delays a large payment or completely defaults resulting in a fatal bad debt;
- Poor debtor control;
- Allowing credit without checking for credit worthiness;
- Poor or no financial control;
- Being under capitalised in the first place increasing the risk of over-trading;
- Accepting large sales orders without first forecasting the effects on working capital and again increasing the risk of over-trading.
- Poor security policies and procedures.
The list could go on, but there are two clear themes emerging that we should look at in more detail: a) the need for financial planning and b) the need for financial control.
A major customer, or for that matter a significant number of smaller ones, delaying payment or defaulting is a real risk in a tough trading climate particularly when bank funding is tight. Nothing you can do about that, I hear you say! If your business is overly exposed to one or two really big customers you need to watch them carefully for signs that they are in trouble - news (even gossip), listening for tell-tale signals from your contacts in the customer's business. Sounds like paranoia, but such events are rarely sudden, and it's your money that is at stake.
Reliance on one key customer is quite common, but risky, and in the longer-term such businesses should develop a strategy to create a more balanced customer portfolio. You should plan for an increase in debtor days and bad debt anyway, which means that you will need the working capital to cover this. Having a strategy which simply relies on you delaying paying your own creditors is not sustainable.
Creating a simple cash budget will allow you to forecast the effect on your bank balance if and when customers slow down payments. Forecast for a percentage of your debtors to default i.e. you might allow for 5% of debtors as a bad & doubtful debt contingency, but study your customers and their past records of payment because in a higher risk customer portfolio the contingency may need to be higher.
Having a forecast will also allow you to predict the effects on your cash balance of taking on that large exciting sales order which you will have to fund until the customer pays. For more on this see our website:
Don't bury your head in the sand, check your bank balance regularly - I mean several times a week, not just when your statement arrives at the end of the month. Up date your cash forecast when you have new information, and this would likely be weekly. Have a column on the forecast at the side of the budget for the actual cash in and out as of the last day of the month and compare the two; do this as soon as you can after the month-end and adjust the forecast for the next few months based on your current performance and your view of the immediate future, but most importantly take corrective action.
Bank funding is very tight, but banks and other funding bodies are still open for business. If your forecast is telling you that your bank balance is at risk of dipping into the red or below the agreed overdraft limit talk to your bank relationship manager as soon as possible. Bank lending is based on their assessment of risk, a business that shows it has a robust planning and financial control process is more likely to get support than the proverbial ostrich. Seek advice from your accountant and Business Link adviser.
But I can't afford the time to do all of that! Ok, but it's your business that's at risk, can you afford not to?
Good day-to-day credit control is essential to survival; some suggestions:
- Credit checking new customers is cheaper than a crippling bad debt; you could:
- Buy a credit rating report;
- Ask for trade references;
- Ask for a bank reference;
- Study historical accounts;
- Look for press reports on the company.
- Ensure that your terms of trading are clear before the sale is agreed, issue them with every invoice and ensure you stick to them.
- Consider asking new or risky customers for cash with order, or cash before shipment, or cash on delivery.
- When net credit days are given, send the invoice with the goods so that the clock is ticking from the delivery time.
- Get on first name terms with people in their accounts department and phone the customer within 24 hours of their receipt of goods to ensure no problems with the order and or the invoice. This helps avoid a common delaying tactic.
- If terms are say 30 days, call the customer on day 31 from the invoice date to ask about progress of the payment.
- Send a month-end statement of account to the customer as a matter of course.
- If still no payment, call every few days to chase it, but reinforce this with a more formal letter, at say day 37, to the accounts department in the first instance followed by a final letter to the MD or FD if still no payment despite promises. Be courteous and succinct at all stages.
- Ensure that the face of the invoice says that you are aware of your rights under rights under the Late Payment of Commercial Debts (Interest) Act 1998 i.e. “We understand and will exercise our statutory right to claim interest and compensation for debt recovery costs under the late payment legislation if we are not paid according to agreed credit terms.”
- Consider stopping further supplies.
- Arrange to meet the company if the amount is significant.
- Consider retaining a collection agency.
- A final recourse is that you could seek to wind up the customer's company if the debt is £750 or more, your customer will know this so use it as leverage before setting it in motion.
- Use your judgement throughout the whole collection process to ensure you don't risk a valuable customer, but at the same time protecting your own company.
- You could consider invoice discounting or factoring, this can be lower risk than overdraft, but is often more expensive and difficult to reverse.
- Take up debt insurance (often called credit insurance).
We can provide you with free, impartial, skilled advice, just call us, or visit our website.
That's all for this month.
Business Link - the place to go for business support