27 Feb 2023
by Menzies

Credit Management: How tough should you get?

One of the key obstacles when keeping on top of a debtors ledger is that often, business owners are afraid of damaging long-term customer relationships. Therefore, it is important to strike a balance between allowing customers some flexibility and setting boundaries. So, how far should you go when asking customers to pay on time and what should you do if late payment becomes a problem?

When thinking about the most effective way to encourage customers to pay on time, it’s helpful to consider the ‘carrot and stick’ approaches. A good example of the ‘carrot’ approach would be a scenario in which the business makes it as effortless as possible for the customer to make a payment on time, for example, making sure that exactly the correct amount has been invoiced, the precise corresponding delivery notes are available, and they correspond to the correct purchase orders raised. You could also consider introducing software, such as an online payment portal, to ensure payments can be made as efficiently and easily as possible.

Getting the timing right is also an important factor to consider. For example, an invoice is much more likely to slip down the customer’s list of priorities if it arrives at 4pm on a Friday. Keeping the timing consistent each month also helps customers to know where they stand, assisting them with their cashflow planning.

Another technique decision-makers should consider is incentivising businesses to be good customers by offering a discount for prompt payment. However, controls must be prepared and care taken to ensure this approach works for the business. For example, decision-makers will need to ensure that late payments don’t lead to an automatic reduction and instead of offering repeated discounts, it may be worth considering one-off incentives instead.

What approach can you take to keep on top of debtor ledgers?

1. Use the ‘stick’ approach

The nature of the human psyche means that people will generally try to push boundaries, where possible. As the customer’s priority is to manage their own cashflow, they may look to exceed their payment terms if possible. As such, it’s crucial to set a precedent by consistently requiring customers to pay on time and using the stick approach to reset boundaries if payments start to slip. Additionally, the business can also set a positive example by making payments to its own suppliers on time and promoting its reputation as a good customer.

Alternative examples of the ‘stick’ approach to credit management are last-resort measures, such as appointing a debt collector, or petitioning for a company to be wound up. Despite there being a time and a place for this kind of action, it’s worth remembering that these are short-term solutions and are likely to damage valuable customer relationships.

2. Knowing the difference between ‘good’ and ‘bad’ customers

This is vital for decision-makers when making tough decisions. From a cashflow perspective, there’s little value in having a profitable customer on the business’ books if they cannot make payments on time. In this instance, the business may be spending large amounts of time and resource chasing payment, which could be better invested in new business activities.

3. Don’t put all of your eggs in one basket

Even if a customer is reliable or places a lot of business, cashflow would likely take a hit if they stopped paying. In many cases, a clear sign of a good customer is how open and transparent they are in terms of communicating with their suppliers. Another sign of a good customer is that they are likely to keep the supplier updated when they’re going through financial difficulty, so the business can plan accordingly.

4. Maintaining a healthy cash flow

In the current climate, business owners must focus on maintaining a healthy cashflow and can’t afford to let customer payments slip. Through careful consideration around the best way to incentivise prompt payments and setting clear boundaries, good credit management doesn’t have to come at the expense of valuable long-term customer relationships.