In business, customers who can’t or won’t pay their bills kill cash flow and profits. What can you do about it? Plenty! Use these seven proven steps:
- Written Credit Policy – If you don’t have one yet, do it. It’s powerful. Meridian clients report amazing results from completing this single step.
Why write it down? Because everyone in your company and your customers need to know your credit policy. The other wonderful thing about a written credit policy is the productive discussions that will occur as you put together your document. You may be astounded by the different viewpoints on credit already within your company. Once the document is written, there will no longer be any ambiguity. Your credit manager should be held accountable for periodic (no less than annual) review and modification of your company’s credit policy.
- Require complete applications – When we ask clients to analyze bad debt accounts, it’s amazing how many files contain incomplete applications. Missing information should be a red flag to your sales and credit personnel. Insist on complete credit applications. Your credit policy should be explicit about this requirement. It should also clearly delineate the handling of and accountability for incomplete applications. In some companies, those applications go back to sales. In others, credit personnel arrange for the prospective customer to provide the missing information without involving sales. There is no right or wrong method, just be consistent.
- Credit Department Goals – Every company should have credit goals that are known and monitored. Typical goals include percentage of accounts current, percentage of dollars current, monthly A/R Days Sales Outstanding, Write-offs, etc. Less common but very effective goals include percentage of complete applications, percentage of customer files with annual review completed, and percentage of risk-rated accounts (see next step). No matter what the goals, they will bring awareness to the importance of being paid on time!
- Risk Rating System – One of the more sophisticated yet effective methods to reduce bad debt is use of a risk rating scale on all customers. We endorse a simple 1 through 5 rating (1 equals virtually no risk with 5 being high-risk accounts).
Risk ratings should take into account the riskiness of each customer’s industry as well as that company’s individual financial condition. For instance, a few years ago, paper mills in the Southeast and lumber mills in the Northeast were both high-risk industries.
Financial condition ratings should center on cash and available cash for vendors as well as payment trends histories with other vendors.
Once your company has settled in on the criteria for each of the five risk ratings, each account should be reviewed against the criteria and the rating posted. This may seem like a daunting task to your credit department, so start with new applications and then work through the old accounts prioritizing late pay, high credit limit accounts.
Ideally, the risk rating should be posted and clearly visible on your system’s order entry screen. Sales personnel should be made aware of customer risk-ratings, particularly if company pricing utilizes risk-rating-driven matrixes. If your company chooses to serve high risk accounts, then you must price those accounts with higher-than-average gross margins consistent with expected loss ratios to remain profitable in that sector.
- Monitoring System – Credit doesn’t begin and end with the first sale. Many bad debt accounts were good accounts for years until something, be it external or internal, changed. Develop a monitoring frequency based on risk rating and the dollar amount of credit. High dollar, high-risk accounts should be reviewed at least quarterly. Then put accountability in place (via departmental and individual goals) to be sure that account reviews are happening on a timely basis.
- Call Frequency – Your sales professionals should visit large dollar and high-risk accounts often. You may also want to include driver feedback on these customers. Drivers often have good intuition about accounts under financial stress.
- Weekly cross-departmental meetings – Yes, sales and credit can sit in the same meeting together and they should! At first, they may seem like oil and water, but with coaching, teamwork will begin to happen. After all, it’s to everyone’s benefit to have sales and credit talking to one another and working cooperatively on both new and existing accounts.
With a written credit policy, complete applications, credit goals, risk ratings, effective monitoring, and call frequency for each account, plus weekly interdepartmental meetings, you can make getting paid the normal course of business it should be!
