Cash flow is a universal consideration for businesses that, when not managed properly, can have a severe impact on everything from the day-to-day running of the organization to its long-term future. Its role has been summed up by management consultant Peter Drucker, who said:
Entrepreneurs believe that profit is what matters most in a new enterprise, but profit is secondary, cash flow is what matters most.
Keeping this in mind, it’s vital that your business has a strategy in place to ensure customer credit doesn’t get out of control. You can employ the following techniques to improve your cash flow and take the headache out of chasing up customers for payments.
1. Assess your customer’s credit practices in advance
Performing pre-checks on potential customers before you start doing business with them can help you avoid any clients that are unlikely to pay promptly. Here’s how to assess their credit practices:
- A credit report will demonstrate if they have the ability to pay
- Bank references shouldn’t be used in isolation, but can help to provide a fuller picture of your potential client as a risk
- Obtaining references from previous suppliers shows the customer’s track record on payments
- Hiring a professional credit checking agency will give you the most comprehensive picture of risk and should be carried out on larger clients
- Asking a customer if they’re happy to adapt a proforma approach where they pay invoices immediately for the first transactions will demonstrate their attitude towards payments
- Look to see if the client has published their accounts and apply the gearing ratio, current ratio or acid test ratio to assess their likelihood to pay on time
2. Establish credit limits with customers
It’s always worth being transparent with customers and setting up expectations from the start. Outlining your payment terms and setting credit limits will demonstrate to your clients what your expectations are for being paid in a timely fashion, as well as establishing some boundaries.
Credit limits should be reviewed regularly to make sure they’re still appropriate for the customer and the economic climate we find ourselves in. Tightening credit limits with clients that consistently pay their invoices late will help to encourage them to settle their account more quickly.
3. Create credit limit alerts
Automating your credit control process will allow you to set up alerts on your invoicing system to highlight when customers are set to exceed their credit limit. This is designed to empower employees to act before extending more credit to a client who is yet to pay an outstanding invoice.
Standardizing this approach will ensure all customers are treated consistently and nobody within your organization feels compelled to make a decision based on an individual client. Using templates to create notifications for clients about reaching their limit can help them to understand the boundaries too.
4. Apply interest and debt collection costs
If late payments are impacting your cash flow and costing your business money, it’s reasonable to pass this on to the client. This is reflected in the law in the UK, which allows you to apply 8%, plus the Bank of England’s base rate, to any delayed payments. On top of this, you can claim debt collection costs, which can vary between £40 and £100, depending on the value of the invoice.
In the US, late fees can’t be more than an estimate of the cost you incurred as a result of the delayed payment. Keep these fees below 10% of the invoice amount calculated on an annual basis to ensure you don’t get challenged on your state’s statutes relating to a reasonable estimate of costs.
Many businesses are reluctant to apply late fees to customers’ accounts as they fear it could damage the relationship. One way to mitigate this is to expressly lay out how fees will be applied in your payment terms so there’s no ambiguity for the client about how you’ll proceed right from the start.
5. Implement a stop list
Ceasing trading with a customer may seem like a drastic measure, but if they’re constantly not meeting their payment obligations they could be doing your business more harm than good. While a stop list means no further goods or services should be supplied by any department of your company until all unpaid invoices are resolved, it’s not irreversible.
Putting the worst customer credit offenders on a stop list should be coupled with clear communication detailing why this measure has been taken. If they settle their debts and ask to resume working with your company, it’s worth putting tight limits in place to ensure the situation doesn’t spiral out of control again in the future.