How to Handle Defaults by Debtors
It’s too easy to be mesmerised by the excitement of a sale, particularly to a new customer, and to ignore the risks of defaults. A sale is not a sale until the customer has been invoiced and payment received. The transaction may appear in your financial accounts but you do not actually receive any income.
You can reduce the risk of bad debt by not selling on credit to customers. But how many businesses pay cash upfront? Probably 1 in 5. Modern businesses take up to 90 days before paying off their invoices. This could have a devastating effect on your company’s cashflow.
Some entrepreneurs can argue that credit checks reduce the risk of non-payment. However, even the most solvent business with excellent credit ratings can run out of cash, leading to a potential default.
Disadvantages of accumulating unpaid invoices
Piling up chunks of cash in unpaid invoices could cost your business thousands or even millions of pounds. If you haven’t already, you need to get a firm grip of your debtors. There are a few pitfalls that can result from weak credit control:
Cashflow troubles – Whilst having to wait 60-90 days to get paid by your customers, your business could require working capital to cover day-to-day overheads and pay staff. This creates a huge cashflow gap between when you make the sale and when your customer settles their invoice.
Risk of bad debt – in case your customers default, the bad debt amount will be written off at an expense to your business.
Increased cost of borrowing – weak credit control means you have less cash available, which triggers your business into borrowing, sometimes at higher rates.
Lower profit margins – By having customers delay payments for invoices, your business could miss out on discounts from suppliers and incur very substantial costs. Remember, less profit means lower dividends.
Credit control via Invoice Finance
Just because selling on credit to customers is part of your business doesn’t mean you should allow them to pay at their convenience. This could be detrimental to your business in the short term.
Credit control is a disciplined and professional measure adopted by companies looking to ensure that customers paying on credit terms settle their bills. This involves chasing customers and collecting payments. That’s why it’s called credit ‘control’ – it’s about being in charge.
Irrespective of your company’s size, credit management could be a very time consuming task. This explains why many businesses use debt collection companies to collect customer payments on their behalf as it works out cheaper for them.
But how about a facility whereby you receive instant cash as well as outsource credit control to a finance provider? This introduces us to the term invoice finance. It’s a cashflow solution where businesses receive cash advances against monies already owed to them. Also, the task of managing credit is handled by the finance provider.
- You invoice your customers and send a copy of the invoice to the factoring provider.
- Up to 95% of the invoice value could be released within 24 hours
- The factoring provider chases your credit customers and manages your sales ledger
- You receive the remaining 5% invoice value balance, less any charges
- Suitable for any type of business with projected turnover of at least £50k
- You invoice your customers and send a copy of the invoice to the invoice discounter
- Up to 90% of the invoice value could be released within 24 hours of issue.
- You retain full responsibility over the administration of your sales ledger and debtor collection – suitable for businesses with in-house credit control systems
- You receive the remaining 10% balance of the invoice value, less any charges
- Suitable for ‘larger’ businesses with projected annual minimum turnover of at least £250k
(See also our business advice article The Difference Between Factoring and Invoice Discounting)
Factoring could be a cost-effective facility for businesses short of working capital. If your business is comfortable with managing its trade debtors, then invoice discounting could be a more attractive option. Invoice finance (factoring and invoice discounting) could be administered as a non-recourse facility, offering bad debt protection which improves cashflow certainty.
Benefits of outsourcing credit control to a factoring provider
- Allows you to concentrate on growing your business
- Benefit from competitive pricing between factoring providers
- Your customers could settle their bills out of respect for the factoring provider
- The experience of the factoring provider could enable you receive payments faster
This business advice article is from www.invoicediscounting.uk.com, the invoice discounting specialists.