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Accounts which are not settled within the terms of business costs money. This apart, the longer an account is outstanding the less likelihood there is of a settlement by normal methods.
A doubtful debt is incurred when all normal debt collection procedures have failed to bring about settlement and is passed out to solicitors. Although doubtful debts can be minimised by prudent credit granting they can never be eliminated altogether, and every year without fail a percentage of accounts are dealt with by the Courts. This method of debt collection is expensive and in order to reduce both losses and costs we should familiarise ourselves with some of the warning signs of the potential doubtful debt. However, before dealing with these in more detail, let us turn our attention briefly to the collection of and reasons for normal slow payments.
Have the invoices and statements been sent out on time? If not we cannot expect prompt payment. It is not unreasonable to suggest that customers have fixed dates on which payments are processed and if our accounts are not rendered within reasonable time they will not receive prompt attention. Are there any queries or credit notes to be dealt with? A queries register/software/computer system is invaluable and should be kept by the Credit Controller. This will show at a glance which accounts are in dispute, and also enable the credit controller to ascertain the reasons for the query. Outstanding queries and credit notes have a habit of being used by the customer to withhold payment of the total amount due and whilst there is no legal right to do this one can see the principle involved. To obtain prompt settlement of our accounts we must ensure that all disputes and queries are settled as quickly as possible.
Another cause for non payment is the inability of the creditor to quote order numbers. This is more common to the larger company where the only means of verifying purchases is by the use of order numbers which unless quoted on invoices result in non payment.
Form (chasing) letters should be changed as frequently as possible.
When using the telephone a record of a conversation or of any arrangements should be kept. When making arrangements, remember to be specific e.g. stipulate fixed dates and amounts.
A diary system should be used.
Whichever method we use for collecting accounts it must not be forgotten that whilst the basic objective is to collect outstanding payments, we must in the interests of continued business maintain goodwill.
The first indication of trouble may be the need for customers to resort to "on account" payments. This can be caused by:
All of these are pointers of bad management and it is this that is the fundamental cause of business failures.
Overtrading
It is generally accepted that overtrading is the biggest single cause leading to business failures, appreciation of this fact in itself does not develop the skill essential to the early detection of overtrading symptoms. Many people rightly say, this or that company is creating an order book situation which is excessive in relation to working capital. Assuming, therefore, that a reputable customer has a normal spread of purchasing sources increases in the amount of credit which may be required from a single supplier arises simply due to the fact that their own turnover is showing a proportionate increase. In appraising the situation, the basic skill required is to establish the climate in which this increased turnover has been secured. e.g. Turnover at any cost, with a shortage of Working Capital will immediately result in failure.
Lateness in Payment
There are numerous reasons why accounts are not paid to terms, there are those companies who regard it as a right, and will not pay unless served with a Claim. However, the most common cause for delay in paying accounts as and when due is a shortage of working capital.
This situation will frequently be found in those companies which are over extended and lack the capacity to attract additional capital and rely on suppliers to finance their activities. It will generally be found that such companies are able to survive long enough and create additional debts by robbing Peter to pay Paul.
Should this situation become uncontrollable, it will be found that the customer is almost entirely supported by creditors to the tune of several hundreds of thousands of pounds, who very rarely see a dividend in the event of failure.
The first indications of impending trouble will be detected as a result of the customer ignoring collection letters, or by him offering various excuses, and where these circumstances exist it is advisable to exercise effective sanctions and implement vigourous collection procedures.
Should the outcome of such activity be successful, credit should not be reinstated until a thorough reassessment of the customer has been made.
Collections
To be effective debt collection procedures must be regular and become progressively more severe as a debt proceeds further beyond the due date. By adopting regular progressive follow-up procedures we not only make the debtor aware of our intentions, but also avoid the necessity of having to take sudden harsh action which could impair trading relationships.
When there is a large number of accounts to be dealt with, the initial stages of debt collection will usually be by the use of form letters. However, the effectiveness of these is determined by the content, and the same letter going to the same customer month after month will have no effect on the habitual slow-payer, after all this type of customer knows just how far he can go. By the same token the credit department may come to expect payment by a certain date and merely send out collection letters as a formality. Adopting this attitude can be costly, not only in terms of increasing the risk of a bad debt but also in terms of interest on the sum due.
To avoid this situation the content of form letters should be frequently changed and where circumstances personal letters should be adopted.
Telephone collections should be used whenever possible as they are far more effective.
Not pressed hard enoughOne frequently hears the expression "they're alright they always pay on the 9th day of the month", or "we do not wish to upset XYZ Limited". The longer an account is outstanding the more difficult it becomes to collect, in addition the risk of loss is greater. It should be borne in mind that where there is a shortage of liquidity, those creditors most likely to be paid are those who press the hardest.
Credit Allowed Despite Poor References and other adverse Information
On completion of status enquiries a general build-up of the customer will emerge, and where this is adverse, normal credit should not be allowed.
Goods/Services Supplied on Credit instead of Cash
Comprehensive records must be available on authorised accounts. Providing they are aware it is inexcusable for personnel to allow a situation to arise where goods/services are supplied on credit to any customer not having approved credit facilities.
Increased Facilities Allowed on insufficient Information
There is a general tendency once an account has been opened for additional orders being received, or a request for extended credit, thereby placing pressure on the authorised credit limit. Prior to raising the any customer updated status information must be obtained, and this will include:
By applying a methodical and careful approach to this area of credit, a realistic assessment can be made of the progress being made by the customer. In the event of failure to comply with such procedure, increased facilities will be granted not as a direct result of the status of the customer, but to accommodate turnover.
Deliveries Made Pending Official Opening of Account
To avoid the dangers to be found in temporary accounts these are, where possible to be avoided. Whilst it is not unreasonable to ask an unknown customer for cash payment until such time as enquiries have been completed, it is preferable to sanction credit prior to the initial order being placed, appraisal being made in accordance with known requirements of the customer. Inter departmental liaison and co-operation is as essential as administration to establish the customers good faith, whilst implementing an effective basis of control from the outcome.
Financial Information
The use of financial information is very important in the assessment of credit worth and is now common practice. This information can now be directly obtained from Companies House on payment of the appropriate fees
Approach your customer for copies of the last audited management accounts. It should be borne in mind that responsible companies including partnerships will keep books of accounts and at regular intervals produce interim financial reports, and where a request for financial information is refused or met with evasion, then it is an indictment that in all probability the company is in financial trouble.
Directors Resignations
Although a limited company is a separate entity, it will be found that policy is dictated by its directors, and in the private sector this is akin to dealing with partnerships in as much that the company's reputation is founded on that of its directors. However, it is not unusual to find the success of a company being due to the expertise and/or financial backing of a single director. It would follow therefore that the resignations either singly or collectively may have serious repercussions on future policy, and where such resignations are known to have taken place, it is necessary to monitor the account until it has been established that policy has not been effected.
Takeovers and Mergers
When it is known that a takeover has been effected, the debtors ledger should be inspected and the current position of both companies involved be ascertained. Should it be found that there is no knowledge of the purchasing company it would be prudent to obtain status information before continuing with the credit to its subsidiary.
Takeovers, depending on the reputation of the company being taken over, have resulted in the purchasing company running into serious difficulties and where it is found that both companies have poor reputations, these may well prove to be insurmountable. The same principle applies to companies that merge.
Failure to Provide Guarantees
Experience has shown that when credit has been given after failing to obtain guarantees, losses through bad debts have been incurred.
Whilst the reasons put forward for refusing to guarantee an account are numerous, such refusals may generally be interpreted as a lack of confidence in the ability of the company in question. When these circumstances exist the risk becomes inordinate and the wise supplier will be well advised to trade on a cash basis, or where the guarantee has been proposed for an amount in excess of an existing limit, trading should be restricted within the pre-determined limit.
Dependence as a Trade Reference
To detect the potential failures in this category it is necessary to note in the customer file details of any applications for reference, and where frequency is considered to be above normal, it is possible that customer is over-extending himself. In these circumstances reassessment of the account should be undertaken without delay.
Sanctions Imposed by the Creditors
Whilst it is necessary to obtain as much business as possible, it should not be at any price and where orders are obtained from competitors' customers, of whom there is no previous experience, or a small account is in existence and the value of the order is larger than normally seen, both sales and credit departments should carry out a thorough investigation.
In addition to the foregoing a number of doubtful debts are incurred for the following reasons:
Dishonoured cash sale cheques
Bad debts are incurred by cash sale transactions. When cheques are tendered they should be supported by a banker's card. Where this is not possible it is advisable not to supply goods until clearance of the cheque of the cheque if obtained.
Correctly opened and well conducted accounts
It is an irrefutable fact that bad debts do, and regrettably always will arise within this category even though the accounts in question have been correctly opened by careful appraisal having regard for all the known credit factors appertaining. It is contended, however, that bad debt losses incurred within this sector, constitute one of the highest loss areas. However, if this statistic is to be accepted as fact, then either the basis of analysis must be challenged or alternatively the factors from which it is concluded, that the account has been correctly opened, and well conducted are erroneous. Individual viewpoints must of course play a significant part in the process of credit sanction and it is reasonable to say that an account which is considered to be more than an average risk by one appraiser would be viewed with extreme caution by another.
Disparity of opinion normally arises when two appraisers are in possession of conflicting information. On the one hand a credit manager may have collated all the facts available, including financial information, and yet ignored the historical nature of these reports. Conversely, the so called pessimist would ensure that he is in possession of all the facts, including the most recent financial information, and his appraisal would be made accordingly.
Legal Actions
Appreciating that there are exceptions albeit these are rare, the principal cause of a legal action is the inability to pay an account that is due.
Partnerships/Sole Proprietors
One of the most common difficulties is where an existing customer who has been trading as an individual or in partnership decides to form a limited company. This of course means that a separate entity has been created and before credit facilities can be continued, the limited company has to be assessed. Generally speaking, such companies are £100 with 2 £1 shares issued variety. Whereas previously members trading as a partnership had unlimited liability they now have the protection of the Companies Act and liability is limited to their shareholding.
When dealing with established customers it is quite frequently found that increased credit limits have been given on payment record alone. Although this is helpful to any assessment, it is insufficient in itself to justify increases. However, it would be foolish to suggest that small increases should be withheld until the account has been reassessed. By all means accommodate the customer, but having done so, the account is to be reassessed as it is possible that other orders in excess of existing limits will be received.
To conclude. The above notes are intended to be a guide to the pitfalls in credit sanction control and provided prudent measures are taken in each aspect the number of bad and doubtful debts will be reduced.