SME cash flow risk can be avoided with proactive credit monitoring – here’s how



Finance

By Roger Mendelson

It won’t come as a surprise to hear that inadequate cash flow is one of the main reasons why many small businesses in Australia fail, so for small businesses looking to get ahead, minimising the risk of bad debt should always be front of mind.

With over 97 per cent of the 2.2 million actively trading businesses in Australia being small businesses, owners are constantly placed in situations where new customers need to be assessed.

Commonly overlooked by SMEs, the idea of credit management can be overwhelming and complex. Large organisations have credit departments and databases, constantly assessing the risk of granting credit to new customers. Without these resources, how can small businesses accurately assess credit risk?

There are many basic steps small business owners can implement in their business processes to accurately assess new customers’ credit risk and protect cash flow.

How good are small businesses at credit management?

Prushka’s recent Canary in the Coal Mine report provides insights into the current SME landscape. It showed an improvement in the way small business manage their credit processes however there is still a tendency to wait too long in referring overdue accounts to a debt collection agency.

There is a perception that holding onto debts before referring them on could upset customers, however large organisations lack this sensitivity, standing strong by not wanting customers who don’t pay overdue accounts promptly. With small businesses contributing 33 per cent of Australia’s total GDP[1], it is imperative they are proactive in assessing credit risk.

The report also found that while SMEs’ financial processes are improving, there are still areas of concern. The number of SMEs with a cash buffer in place to deal with cash flow issues continues to rise, and the reducing reliance on banks indicate stability in the sector. However, more than one in five operators rely on personal funds if they run into cash flow problems. While it is a better approach than relying on bank loans, it does leave business owners at risk if their cash flow takes a big hit.

The longer a debt is left unpaid, the harder it is to recover. Waiting 90 days before referring a debt to a collection agency significantly reduces the chances of being paid, yet SMEs continue to procrastinate. Piling up of bad debts can have a significant impact on cash flow down the line.

What are the warning signs of bad debt?

There are tens of thousands of businesses running in Australia without any significant assets behind them. In these instances, if they are sued or a creditor takes action in winding them up, they simply abandon the company and begin again under a new business name.

Appearing sound at first, these new customers might not raise immediate alarm bells. Collecting money owed from these businesses is near impossible as they are simply not worth suing.

This may sound like a nightmare situation, however it shows how important it is for SME owners to take some very basic steps, with minimal cost, to reduce the risk faced in granting credit.

Assess credit risk first

It’s far safer to avoid providing credit in the first place or providing it with strings attached, rather than chasing an impossible payment.

An easy way to start is to complete an ASIC company search:

  • When did the company form? If it was just a short time ago, be wary.
  • Who are the directors? Are they the same people you’re dealing with?
  • Is the name of the company the same entity and ACN as the new customer?
  • Have there been applications in the past to wind up the company?

Cover your bases

Provide the new customer with a simple credit application form – it’s important to remember that this will not lose any business for you, it’s all about minimising risk. To save time, customise a credit application form, which covers all the bases.

It’s also essential to obtain references. A few minutes spent in speaking to referees will either provide you with peace of mind or a cause for concern. If the customer is unable to provide you with meaningful referees, take it as an early warning sign.

Another simple process when providing credit to privately owned companies is to obtain guarantees from the directors. You can customise a director’s guaranteed document to suit your business needs in order to minimise risk.

How do you knock back risky business?

Extending credit to new customers is valuable in increasing business, as it will give you an edge in the market place. However it’s important to carefully assess each lead to minimise the risk of bad debt. You don’t want to knock back new customers unnecessarily, but if your basic checks have caused concern consider the following:

  • Require payment on delivery of the product you provide or alternatively, request a substantial deposit
  • If you provide services, negotiate an agreed billing program with tight payment terms, so that you bill as you go. If there is a default in payment, stop providing the services until the payment is corrected

Roger Mendelson, CEO, Prushka Fast Debt Recovery


[1]ASBFEO Small Business Statistical Report 2016

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