Outstanding accounts represent a high proportion of capital employed. A company's debtors are an investment - you only earn the profit when the sale is paid for - and so, as with all investments, you must assess the risk before taking the plunge and accepting a new customer. In other words, is the new customer a good bet? People who do not pay you promptly are taking unauthorised interest-free credit at your expense (and very much so, if you are paying for overdraft facilities or loans that you would not otherwise need).
It could be said that the purpose of credit management is to acquire good business for the company. The front end of this process is to check potential customers for creditworthiness before deciding whether or not to accept or reject them on a credit basis. Credit checking, however, should not be seen (or used) as a means of weeding out all potentially unsuitable customers - after all, you want your business to grow. Rather it is an assessment of how big a risk you would expose yourself to were you to accept the customer, and how much you are prepared to chance.
When controlling your receivables ledger, it helps to have an established policy. This lets both you and your customers know where they stand. The first step is to establish credit terms - net 14 or 30 days, for example, so that you know when collection action should commence. The two most commonly used methods are reminder letter and/or telephone collection.
The four main reasons for late payment are:
Inefficiency - common excuses include 'we are going onto computer', 'we are short of staff', and so on. It can be helpful to find out how the invoice approval system works; also, if you get the chance to meet the person responsible for passing the invoices for payment, do so - the fact that they can put a face to the name when they come across your invoices can often speed up the process. Ultimately, you must be tough with these customers, but it might be worth being patient if the problem is short-term rather than endemic.
To help you to keep an eye on your debtors, it is necessary to have a measurement system which allows you to compare month by month what is overdue, and which would not be distorted were you to have either an unusually good or bad month saleswise. A common way of doing this is to measure the days sales outstanding. To do this, you assume all months have 30 days and work out the average day’s sales.
There will be times when despite your best efforts, your customer simply will not pay. In these circumstances, you need to be prepared to take things a stage further. It helps if you keep your eyes open for the danger signs and a plan of action will help you to be aware of potential problem accounts.
Spotting the first signs of danger:
Legal action may arise for several reasons, including chasing unpaid accounts, breach of contract, personal injury, etc. The chasing of debts is a time consuming and often expensive process. However, procedures within the Small Claims Courts have been issued to reduce the time and expenses of small claims cases. The Small Claims Court in England and Wales is designed to resolve disputes where the sum involved is £5,000 or less. The majority of these cases are handled through a system of arbitration. Arbitration is an information hearing of the case before a District Judge. It allows small claims to be dealt with quickly, cheaply and informally by allowing the creditor to present his or her own case without the use of a solicitor. Where larger amounts are involved, most people will prefer to use professional representation in the courts.
To be insolvent is defined by the Oxford Dictionary as being unable to pay one's debts. Companies who find themselves insolvent can endeavour to either wind-up and liquidate the company or re-finance it and continue trading.
Faced with an insolvent debtor you should first try to identify ways to recover your money. It is important that lessons are learned from such experiences, and so you should also look for ways of avoiding recurrences in the future.
