Trade credit in a COVID-19 world: The early bird catches the worm
“The early bird catches the worm”. That’s the key principle when it comes to managing your debtors, and especially now. Being the Early Bird is about being proactive, engaging customers quickly, understanding their positions and risks, offering options. It also means making difficult decisions, balancing recovery against customer relationships.
At 1Centre, we’d like to help our customers be the Early Bird.
We’ve developed a credit policy framework available to our Suppliers, that will provide a structured approach for onboarding new customers, and we have two great ideas for collection and improved credit monitoring, enabling you to assess and change your responses as things evolve.
Let’s jump into it!
Critical questions to consider
#1. What is more important to your business – immediate cash flow or full recovery of amounts owing? Putting this in more immediate terms, would you prefer to get 90-95% in the dollar now, or 100% over 3 months.
#2. Do you have security clauses in your credit T&C’s?
#3. Are you receiving regular updates to monitor credit risk?
#4. Do you maintain an active watch list of third parties that are perceived to be of concern?
#5. How reliable is this information (#3 & #4)?
a. Sort your debtors' list from largest to smallest, start working on the largest 70-80% by value. It might help to put these into a spreadsheet if you are not capturing this information anywhere else.
b. Calculate the gross margin (%) and amount owing after deducting gross profit– we’ll use this below. This can be debtor specific or average, depending on what information you have available – again in your spreadsheet.
c. Mark each debtor as High/Medium/Low Risk (H/M/L) based on what you know: payment history, credit rating, security, current arrears, etc – you may obtain more info if/when you speak to your customers – spreadsheet.
Immediate actions to consider
a. Consider putting the accounts that are marked High Risk on stop until such time you feel confident in repayment, or another resolution.
b. Review limits – especially those marked as High & Medium Risk. If a customer is already stretched, you want to prevent them from running up more debt with you.
With 1Centre, it’s easy to make these changes.
COLLECTION: Two ideas for collection
Going back to question #1, what is more important to your business – immediate cash flow or full recovery of amounts owing? What if you could get some of your customers to pay early or when due – could you allow others to pay later?
We have two ideas - which you could combine to create options for you and your customers:
A. OFFER YOUR CUSTOMERS A “COVID-19 GOODWILL DISCOUNT”
- This is a great way to get to the front of the queue and shows your customers you’re being proactive
- This could be individualised or a blanket discount
- Individualised means the discount could be offered only to select customers and/or the % discount can be tailored
- A blanket discount approach is where a discount approach is offered to all customers, for example, 5% for early settlement and 2% for payment on the due date
- Factors to consider in setting a discount:
- How important is it to have cash now?
- Profitability: if your customer is generating a Gross Margin of 20%, offering a 5-10% discount still leaves you in a profitable position even if it hurts your bottom line short-term.
- GST: Remember that if you offer a discount, GST forms a part of this – so a % of the cash flow saving for your customer is GST, and this also reduces your GST payment to the government.
- Tax: You also get a tax deduction of the write-off.
- A deeper discount might be appropriate for a High-risk customer– 10% might get them to pay, 5% may not be enough.
B. OFFER YOUR CUSTOMERS A “COVID-19 SETTLEMENT PLAN”
- For customers that simply can’t pay immediately, offering a structured payment plan is a proactive approach to formalise a commitment to pay – and it’s also a good relationship builder.
- Use this option to address shortfalls in your security – when entering into a repayment plan, customers could be asked to agree to additional terms.
- It gives you the opportunity to ask those more difficult questions, such as:
- What risks are they facing?
- What limit do they need to continue trading with you?
- When do they expect to place new orders and how much?
- What customer concentration risk do they have? They might be owed a lot of money by a single customer, which can have a domino effect down the supply chain – do you remember the Mainzeal case...
- How well capitalised (funded) is your customer - why are they taking this discount?
- Some things to consider:
- Reduce the account limit to the amount outstanding – or put on stop until paid
- Keep the repayment window short if you’re able – ideally 2 to 3 months depending on the situation.
- The repayment could include penalty interest, credit card charges and/or admin fees
- Be clear about what happens if they don’t pay – you are helping them, but in exchange you expect them to play ball.
- Again, this approach could be individualised or a blanket approach.
MONITORING: Knowledge is power
Putting both options out to all your customers ALSO gives you very valuable information. How?
Those that choose to take advantage of the goodwill discount and pay early are likely to be well funded. They have the money to take advantage of the discount, right? This is a good indicator that they are at low risk. Take the opportunity to strengthen your relationship with them, talk about how you can work together more closely in this crisis.
More importantly, those that are interested in the repayment plan are signalling that they are either in distress (worst case) or they just want some extra runway on payment. Either way, this opens the door for you to get more information, better security, and a commitment to pay. Isn’t that better than just hoping they’ll pay?
1CENTRE: Tools to help you out!
Every 1Centre virtual credit file, has all the original information attached to it, from when your terms were originally agreed. To further enhance the file – you can also:
- Credit control:
- Notes – firstly, make sure you capture notes, so anyone who refers back to your conversations can access this information easily and can refer to the application itself.
- Stop credit - If this is the option you pursue, you can use this easy to use functionality in your account, including adding notes so key stakeholders in your business are informed about why the account is on stop and what remedial action is in place to support your customer.
- Review dates – You can also set review dates, enabling an automated notification so you don’t miss any follow ups you agree on or you feel are required.
Credit control is fast evolving for 1Centre users, so keep an eye out for new functionality and tools coming your way shortly.