Should you provide credit to your customers?

Should you provide credit to your customers?

Trade Credit

While offering credit is a valid way to increase your customer base and the demand for your goods and services, it is important to manage the risks of offering credit and to understand how this can affect your cash flow and your solvency.

There are several risks business owners/directors must consider when deciding to offer credit. The two primary risks are as follows:

  1. A reduction in liquidity which in turn, may affect a business’s ability to pay its debts as well as purchase required assets or inventories and stay on top of employee entitlements.
  2. A permanent loss of revenue if a service or product is provided to a recipient who doesn’t have the ability to pay. This is quite common in industries such as construction where significant time is invested and a service is provided before payment is made.

There are several strategies business owners/directors can employ to mitigate the risks of offering credit in order to take advantage of increased sales.  These include:

  • Having a stringent credit application process that may include performing a credit check and carefully vetting credit references. Other investigations may include completing an ABN Lookup to confirm business and GST registration, obtaining relevant guarantees such as personal guarantees from company directors to ensure payment, and obtaining a history of transactions.
  • Setting and reviewing appropriate credit limits dependent upon the customers’ risk profile, reducing the risk of losing large amounts.
  • Communicating clear credit terms on all invoices and promptly following up customers who exceed these terms. Standard terms of credit are often seven, 30 or 45 days.
  • Making it easy for your customers to pay and checking that they have received the invoice and there are no disputes over items provided.
  • Setting reminders in your accounting system so that the customer will receive automatically generated reminders without the need for you to manually send copies.
  • Keeping up to date and accurate records of your debtors list. Inaccurate master records and invoicing can adversely impact the recoverability of your debtors; for example, if invoices are not being sent to the correct address or do not reflect the correct payment terms.
  • Providing incentives to customers to pay on time.
  • Keeping payment terms for customers shorter than those with your suppliers to help maintain a healthy cash flow.
  • Preparing and continuously updating your cash flow forecasts so you stay on top of expected outstanding inflows.

For your clients who are creditors of big business (over $100m), the new reporting under the new Payment Times Reporting Scheme (PTRS) commenced 30 September 2021. Under this new legislation, transparency on payment practices is increased with these businesses required to report the payment terms they offer to suppliers every six months. This aims to eliminate cash management activity that disadvantages SME businesses that engage with large companies.

For more information on this and other finance-related topics, please contact us for a confidential and obligation-free chat.

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