New customers, new orders from existing customers, and new business opportunities are the adrenalin of every business.
But winning sales is only half the battle; win the battle by getting paid! To get paid, effective credit risk strategies must be used.
The best credit risk strategies are made an integral part of the sale. If the sale to a customer starts on the right footing, then the business relationship generally continues that way. If not, then no matter what ‘catch up’ strategy is used down the track, getting paid is always so much harder.
Here are some simple, cheap and effective credit risk strategies for use up front when winning the sale, to achieve a better cash flow for your business. We look at the following:
- Who is your customer?
- Finding out more about your customer
- Up front payments, accepting credit cards
- Structuring progress payments
- Pricing where credit terms are offered
- Credit suspension
- The paperwork
- Retention of title
- Credit risk management
- Some debt collection strategies
Who is your customer?
Who are you dealing with? Who do
you invoice? Who is responsible
to pay the bill? Take care to
find out who is your customer or
be left clutching at air!
For business customers, start
with the
full
name and ABN. Are they
a person, partnership or a
company?
Where goods are ordered for
delivery, is it the person
accepting delivery at the
delivery address who is
responsible or is it someone
else that is to be invoiced and
is responsible for payment?
Finding out more about your
customer
Once the customer’s proper name
is known, why not find out
something more about them?
If a standard credit application
form is used, information such
as their address, the names of
the directors or principals of
the business, names of major
suppliers and trade references
are required to be given.
Whether or not an application
form is used, or credit checks
are made, for business customers
it is essential to log on to the
Australian Securities and
Investment Commission (ASIC)
website, which contains free
information on every company and
most business customers in
Australia.
The web address is: http://www.asic.gov.au/.
Input the name and the screen
will display the proper name of
the company or business, its ACN
and ABN, whether it is
registered (as opposed to being
in receivership, administration
or liquidation) and the suburb
of its registered office.
If further information is
required, click on the ASIC
information brokers icon for a
paid company search with full
details of directors,
shareholders, company charges
and the like. The full search is
available for about $30 and
could be charged to the customer
as an establishment fee.
A follow up search for business
customers is available on the
Australian Business Register
http://www.abr.gov.au
These public registers will not
provide information on
creditworthiness. For this
information, telephone calls
should be made to the trade
references, and perhaps a credit
check with Baycorp Advantage
(available to members only).
Up
front payments, accepting credit
cards
One off sales to retail
customers (businesses and the
public) are paid up front, at
the point of sale. Nowadays, the
widespread availability of
credit cards and debit cards has
made up front payment for retail
simple and convenient using
those cards. Giving credit terms
such as lay-buys or ‘easy
payment plans’ to retail
customers has almost
disappeared.
For all businesses, receiving
payment by credit card or debit
card is strongly recommended as
opposed to giving credit terms.
The merchant fee is a fair trade
off in return for the
acceleration of cash flow and
the fact that the payment is
effectively made by the credit
card provider. Also, many
business customers prefer to pay
by credit card to accumulate
rewards points personally.
Personal finance is available
for retail customers of high
value consumer goods, such as
furniture, electronics and motor
vehicles, and can be supplied by
either the retailer or an
external finance company. If
finance is supplied, it is often
reflected in the price – see
below.
Structuring progress payments
The easiest sale to make is a
‘pay later’ sale where credit
terms are offered to ‘win the
sale’. It is also the riskiest
form of sale from a business
point of view because a product
or service is provided that
costs the business cash to
provide, without receiving cash
from the customer to cover the
cost. It should not be offered
unless it is the practice in the
industry, or as a genuine
encouragement to a customer to
place more orders.
Having said that, ongoing sales
to retail customers (business
and the public) and sales to
business customers, are often
made on credit terms, with
payments structured as progress
payments.
If it is not possible to receive
up front payment for the full
price, then an up front payment
(a ‘down payment’ or ‘deposit’)
should be required, and a
progress payment arrangement
made for the balance.
Progress payment arrangements
should be tied to delivery.
If the delivery of the product
or the services is in stages,
payment can be staged. If there
is one delivery, then C.O.D.
(cash on delivery) should apply.
If payment is not available on
delivery, in no circumstances
should the product be left with
the customer. The products
should be put back in the van!
It is better not to have a sale
at all than a sale where
collecting payment is difficult
and possibly never received.
Some businesses often have dual
policies, such as to insist on
up front payments where the
price is under a set amount,
such as $200, and provide credit
terms above that amount.
Pricing where credit terms are
offered
If it is always cheaper if you
are paying in cash, is it always
dearer if you want credit? The
answer is yes, because the cost
of credit (that is, interest),
is built into the price. There
are two strategies used by
businesses.
Retailers may offer terms
payments by 24 instalments over
2 years, interest free. How is
this done? The answer is that
interest is built into the
price! This is known as
capitalising interest. For
example, the price of a lounge
suite might be $1,500 if sold
for cash (no terms offered).
Assuming an interest rate of 20%
pa reducible, then the price if
it is sold on terms would be
more like $1,800, payable by 24
instalments of $75 per month
each, ‘interest free’.
In other businesses, where
control exists over pricing, the
business adds a margin where
credit terms are to be offered,
such as payment due 60 days
after invoice. The business then
offers a discount for prompt
payment, of say 5%, if payment
is made within 14 days. If the
price is relatively fixed, add a
credit charge or service charge
payable of the account remains
unpaid for more than 14/30 days.
This charge is not imposed where
prompt payment is received.
Some retailers of expensive
consumer goods introduce their
customers to external
financiers. If the customer
commences principal and interest
payments immediately, then the
retailer can charge an
attractive price, because it is
the customer who pays the
interest from the point of sale.
For example, the retailer may
sell a plasma TV package for
$5,400. If the retailer
introduces an external
financier, it will receive
$5,400 in payment from the
external financier, in the same
way as it receives payment if
the customer pays by cash (using
dollar bills or credit or debit
cards).
But if ‘no payment’ or ‘interest
free’ terms are offered for a
specified period as an
inducement to buy, the price
must be higher. How is this so?
The cost of any interest free
period must be built into the
price, because the retailer must
pay the interest for the
‘interest free period’ to the
external financier. Using the
plasma TV package example, if
the retailer offers 2 years
interest free/no repayments,
then instead of a price of
$5,400, the price would need to
be higher. It might be 20%
higher which is $6,999 (which is
the advertised list price). The
way it works is that the
retailer receives $5,400 from
the financier (the cash price),
the customer owes $6,999 to the
financier but pays no interest
on that amount for 2 years, and
the external financier keeps
$1,599 difference representing
the interest payable for the
first two years.
Credit suspension
Credit that has been given in an
ongoing business relationship
can be taken away where the
customer fails to pay according
to the credit terms. Many
businesses have a ‘credit
suspension policy’ which
requires payment to be made up
front, on new orders, where a
customer is 60 days or 90 days
in arrears.
As an adjunct to that policy,
many businesses will require
payment of the whole of the
overdue amount before accepting
new orders.
The
paperwork
There are two forms of
paperwork. The first is a
customer details application
form, with a Credit Application
incorporated into it. The second
are the Terms of Trade/Trading
Conditions, which are found in
the ordering and invoicing
documentation.
Credit
Applications will contain
personal guarantees of at least
one director, if the application
is made by a company customer. A
company search should be carried
out at ASIC to check that the
person giving the guarantee is a
director. The effect of the
personal guarantee is that if
the company does not pay, then
the director who signed the
guarantee is personally liable
to pay. Personal guarantees are
not required for customers who
are individuals, as they are
personally responsible for the
debt.
Some credit application forms go
further, and give rights similar
to the rights a lender to the
business has. For example, the
business might have the right to
lodge a Caveat upon the real
estate of the personal
guarantor. In other
circumstances a mortgage over
the real estate might be
considered, or a mortgage over
specified goods, which is called
a Trader’s Bill of Sale.
Terms
of Trade/Trading Conditions
are printed on the front or back
of quotations, order forms,
invoices and the like and are
highly recommended for
businesses. After all, their
purpose is to protect the
business from legal liability
and to make debt collection
easier.
Terms of Trade will contain
terms such as passing of risk,
retention of title (see below),
interest charges for late
payment, payment schedules and
the like which relate to credit
terms.
Signing of Credit Applications
and Terms of Trade significantly
improves the enforceability of
credit terms. The High Court has
recently confirmed that ‘A
person who signs a document
which contains contractual terms
is normally bound by them even
though that person has not read
them and is ignorant of their
precise legal effect’.
Retention of title
The purpose of a retention of
title (ROT) clause is so that
the business to retain ownership
of the goods, until payment is
made for the goods. Ownership
can be retained even though the
goods might be sitting in the
customer’s warehouse, showroom
or shop.
ROT clauses are particularly
useful where the customer which
goes into receivership,
administration or liquidation.
Because payment has not been
made by customer, then under the
ROT clause, ownership has not
passed to the customer. The
business can call by the
customer’s warehouse, showroom
or shop with a van and collect
any goods which are unpaid.
Receivers, administrators and
liquidators are none too pleased
when this is done, but will
release the goods provided
proper paperwork containing the
ROT clause is produced to them.
Where the business transaction
is a service, a lien is
available to a business to hold
back the goods or materials
belonging to a customer, upon
which work has carried out work,
until payment. Examples include
motor vehicle repairers,
architects, preparers of reports
such as environmental reports
and planning reports. A lien is
lost, and cannot be regained,
once the business parts with the
goods.
Credit Risk Management
Each business must carry out its
own credit risk assessment to
establish for which customers it
will provide credit terms, how
much the credit limit should be
set at, and for what time and on
what terms such as additional
security by way of personal
guarantees, retention of title
clauses and the like, it will
extend the credit.
Credit risk is heightened in
these circumstances:
- Where the customer is a first time or one-off customer.
- Where the product is of little value once it is handed over or are valuable only to the customer. Examples include printed materials, travel (after the trip), building work.
- Where a business’s margins are small and where giving credit may put the whole business at risk of failing, if payment is not received. Examples include the travel industry where profit margins can be less than 5%, and telecommunications.
- Where the credit limit is set too high.
- Where credit terms have been given, and there is already a large amount outstanding on credit.
Some debt collection strategies
Experience in collecting overdue debts and in writing off bad debts is a great teacher of credit risk strategies.
Here are some debt collection strategies which might assist in obtaining payment and reducing write offs:
- Follow up. Send account reminders – with eye catching stickers, starting with the polite reminder ‘have you overlooked payment?’ and over time, ending with the ‘pay within 14 days or legal action will follow’. Telephone regularly – with the intent of extracting a commitment to pay.
- Review ongoing orders or continuing work to suspend credit, require cash on order and cease work. Beware the trap of continuing to extend credit, or extending further credit to customers which are experiencing financial difficulties, in an attempt to recover a pre-existing debt. Often those customers are trading insolvently and will go into administration or liquidation, leaving not only the pre-existing debt but also the future debt unpaid.
- Send a Letter of Demand or Creditor’s Statutory Demand for Payment of Debt – confer with your lawyer before doing so to ensure that the correct form is being used or have your lawyer do so at an agreed fee. Lawyers are ethically bound in Australia not to take a percentage of moneys collected, unlike their counterparts in the USA, who are able to take a percentage of the amount collected on a ‘no win no pay’ basis.
- Accepting payment of the debt by instalment payments is often preferable to holding out for the full debt. The customer’s written confirmation of an instalment payment schedule is very useful to have as it is an acknowledgement of debt. In a continuing relationship, tie the instalment payments to future delivery of goods and services.
- Engage a mercantile agent to collect the debt. These are professional debt collectors who charge a percentage of the debt collected (often 30%) on a ‘no collection no fee’ basis. They come into their own and achieve success where the business documentation is good, there is a volume of similar debts to collect, the debt is fresh and the debt is relatively routine and small.
- Court proceedings. Statements of Liquidated Claim are able to be issued in the courts. Lawyers and mercantile agents issue Statement of Liquidated Claim, and when they do they add legal costs, court costs and interest to the amount claimed. It is important to decide before issuing a Statement of Liquidated Claim whether the exercise is likely to prove worthwhile. It is not possible to give guidelines to help except to say that the factors to be considered include the amount of the debt due, any dispute concerning the debt, the ability of the debtor to pay and the legal costs of pursuing the debt.
- Lawyers can assist in drafting trading terms, and checking personal guarantee and security clauses. They can also assist in debt collection by writing letters of demand, issuing Statements of Liquidated Claim and negotiating terms of settlement.
The Author: Anthony J.
Cordato is a principal of
Cordato Partners, Business,
Property and Tourism Lawyers,
5/49 York Street, Sydney. He is
the author of “How to Collect
Business Debts”. For more
information, email ajc@businesslawyer.com.au
or telephone (02) 8297 5600.
Important Notice
This article provides a summary
of the law. It does not cover
the whole of the relevant law
and is not a substitute for
professional advice.
Moreover, because it avoids
legal language wherever
possible, there may be some
generalisations about the
application of the law. Some
provisions of the law referred
to have exceptions or important
qualifications.
Your particular circumstances
need to be taken into account
when determining how the law
applies to you.
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