Customer credit risk management

Default arising from customer credit risk is inherently guaranteed in all industries, however, taking certain steps can minimize this risk. You are forced to deal with clients who declare bankruptcy or who are delinquent that can affect your cash; especially if there is a substantial cost associated with serving that same customer. Keeping your Days Sales Outstanding (DOS) ratio as low as possible will mean your business will always have adequate funds to keep operations running.

The DOS ratio simply measures your ability to convert accounts receivable into cash. The lower the ratio, the faster you’ll get cash at the door. On the other hand, a high DOS rate means your business is at higher risk of customer defaults. First, refrain from automatically granting each customer a credit on account. Establish a strict credit policy that is effective and adaptable. The first line of defense is the Credit Application, which must be a robust and rigorous process.

Each customer credit approval process should include credit references from the customer’s existing vendors, recent financial statements, recent tax return, as well as included language regarding late fees and finance charges. In addition, it must detail the amount of credit for which the client is approved and the payment conditions. A common mistake that companies make is that they allow a client to buy beyond their approved credit amount, this is a mistake since it undermines the entire credit application approval process, in addition, your client will now not take it seriously the amount of your credit limit.

As a business owner, you need to understand when it’s time to cut your losses, sell more, or continue to service a delinquent customer doesn’t increase your chances of collecting overdue bills, it just drives you deeper into the hole. It takes a concerted effort to collect outstanding bills. One of the best methods that has always worked for me is to analyze outstanding accounts receivable on a weekly basis, as well as maintain constant communication with each of my clients about where their balances were, as well as determining the expected date of payment.

Maintaining constant communication with your client is crucial as this will signal to your client that you are keeping an eye on their accounts receivable. However, not maintaining constant communication with your clients indicates that you are not in a hurry to collect outstanding invoices. Offering early payment discounts or charging late fees is a good way to encourage a customer to pay their bill before the due date. Common discounts given are 2%/10, which essentially means that you will give a customer a 2% discount on an outstanding invoice, only if it is paid within 10 days from the date of the invoice.

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