effective credit management_timothy mahea

8/6/2019 Effective Credit Management_Timothy Mahea

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Effectivecreditmanagement

Business planning for owner managers


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Work book s in thi s Seri es

Book-keeping

Budgeting

Business PlanningConducting a Business Review

Conflict, Disciplinary and Grievance Procedures

Customer First

Delegation and Staff Appraisal

Developing People

Effective Communication Skills

Effective Credit Management

Exporting for the First Time

Financial Control

Financial Planning and Forecasting

Implementing Quality

Leadership and Motivation

Legal Aspects of Recruitment

Making Meetings Work

Making the Most of Your Time

Managing Change

Managing Information

Managing Resources

Managing TeamsManaging Quality

Market Research for the First Time

Marketing for the First Time

Organising Your Business and Keeping it Legal

Personal Selling Made Easier

Planning Your Personal Development

Premises Management

Problem Solving and Decision Making

Project Planning and Management

Recruitment and Selection

Successful Negotiation

Understanding Financial Statements

Unlock Your Potential

Working With Suppliers

Writing Your First Business Plan

Your Personal Action Plan

Business Development for Owner ManagersEffective Cred it Mana gement

Project North East & Live WIRE Youth Enterprise

Published by Project North EastHawthorn House, Forth Banks, Newcastle upon Tyne, NE1 3SGTel: 0191 261 7856Fax: 0191 261 1910e-mail: [email protected]

This book: ISBN 0 947557 76 8

All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted inany form or by any means, electronic, mechanical, photocopying, recording, or otherwise without the writtenpermission of the publishers. This book may not be lent, resold, hired out or otherwise disposed of by any wayof trade in any form or binding or cover other than that in which it is published, without the prior consent of

the publishers.


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Effective credit management

Project North East 1998 11

!! Controlling your businessIt is essent ial that you have firm cont rol of your businessfinances. You need to be sure that you know how you are

performing and that you are aware of how much you are owed, bywhom, and for how long the debt has been outstanding.

Objectives

The aim of this workbook is to explain how you can achieve andmaintain effective credit control. It will help you to:

% establish an effective credit management system;% successfully collect debt; and,% know what to do should you face a bankrupt debtor.

Companion workbooks, Financial Planning and Forecastingand Financial Control, further develop the theme of financialbalance with in your business.

!! Credit ma nag ementAs you will have seen from your balance sheet, outstandingaccounts represent a high proportion of capital employed. Acompanys debtors are an investment - you only earn the profitwhen the sale is paid for - and so, as with all investment s, youmust assess the risk before taking the plunge and accept ing a new

customer. In other words, is the new customer a good bet? Peoplewho do not pay you promptly are taking unauthorised interest-free credit at your expense (and very much so, if you are payingfor overdraft facilities or loans which you would not otherwiseneed).

Correctly assessing the risk of doing business with someone oncredit terms and making sure you are paid on time can make thedifference between success and failure, particularly for a smallbusiness.

The importance of cash

Companies without cash cannot survive. A company withthousands - or hundreds of thousands - of pounds worth of assetsand a full order book can still go bust due to lack of cash withwhich to fund the business. A major contributory factor to theliquidity of a company is just how quickly you can get people topay you.

The cred it function

The primary objective of credit management is to turn debtorsinto cash swiftly, but without upsetting the business relationship.This requires careful handling. It is a balancing act between thenecessity to impress upon the customer the need for and benefitsof prompt payment, without being so heavy handed that you put


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them off dealing with you ever again; dealing with the presentproblem whilst keeping an eye on future opportunities.

The stages a customer may move through whilst dealing withyour company are as follows:

% credit checking - the initial decision as to whether or not youshould accept the customer, leading to the setting of creditlimits and the agreement of credit terms;

% cash collection - the action t aken when an account becomesoverdue, generally consisting of reminder let ters and cashcollection calls; and,

% debt recovery - the action taken when cash collection doesnot work, often involving legal action.

These processes will be looked at in more detail in t he rest of the

workbook, along with other important factors.

!! Establishing creditworthinessIt could be said that the purpose of credit management is toacquire good business for the company. The front end of thisprocess is to check potential customers for creditworthinessbefore deciding whether or not to accept or reject them on acredit basis. Credit checking, however, should not be seen (orused) as a means of weeding out all potentially unsuitablecustomers - after all, you want your business to grow. Rather it is

an assessment of how big a risk you would expose yourself to wereyou to accept the customer, and how much you are prepared torisk.

For example, a customer to whom you would not grant monthlycredit of 2,000 might be good in the first instance for 500 -after that, if the business relationship proves to be sound andprofitable, you might increase his credit limit on the strength of his account history with you. Alternatively, if he does not payyou might stop his account, but bearing in mind his credit limitwas set at 500 and assuming your terms are net 30 days, goodcredit control should limit your exposure to 1,000. Giving himthe higher credit limit would have meant a risk of 4,000, ormore, if credit control was sloppy.

Consumer credit checking

The most common form of consumer credit checking is to use theservices of a credit reference bureau. They keep records includingcounty court judgements within normally the previous six years,electoral roll registration, and account information from membercompanies. Consequent ly you can find out if your prospectivecustomer has ever been taken to court for non-payment, if theypaid any summonses they received, if they are registered at theaddress they gave you, and how promptly they pay their otheraccounts. (The account history information typically relates to


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store cards, credit cards and mail order agreements, such as thosemade with catalogues, book clubs, etc) . The charge for a check isnormally a few pounds, and whilst it will not tell you if youshould accept or reject a potential customer, it will provide youwith information to help you make an informed decision.

If you plan to offer credit facilities or hire out equipment inexcess of three months to consumers, you will need to apply for alicence under The Consumer Credit Act 1974. There are someexceptions, but if you think you may be affected by this act,contact your local Trading Standards Officer. It is a criminaloffence to t rade without a licence and debts owing will beunenforceable. There is usually a delay in obtaining a licence,and you cannot offer consumer credit without one, so apply assoon as possible.

Tra de credit check ing

Credit checking potential trade customers may be morecomplicated. You need to compile sufficient information to allowyou to build up a picture of the customer and the state of hisfinances. To do this, you need to request information from thirdparties. The most common sources of information are:

% bank references;% trade references;% information from competitors;% credit reporting agencies; and,

% company information.

Bank references

Whilst you can normally rely on the opinion of the customersbank for accuracy, you may have to translate their opinion frombank speak into English. Phrases they may use include:

% undoubted - have no fears about the creditworthiness of thiscustomer;

% respectably constituted, good for your figures - t his customeris a good risk;

% we do not think he would enter into ... - be careful, weigh thisup carefully in the light of other information you can gather;

% capital fully employed - the customer is heavily committedfinancially already; and,

% we regret we are unable to speak for your figures - we haveserious reservations about the financial situation of thiscustomer.

When you request a bank reference, you must be specific in orderthat the bank should know what it is you are asking. They wouldbe hard pushed to offer an opinion on a request which read, IsCompany A good for trade credit? However, if instead you were


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to ask, Is company A considered good for trade credit of 1,000per month on 30 day terms?, you would be more likely to get auseful reply as you have given the bank a figure to use in theirassessment.

There is normally a charge for bank references. You ought to beable to reduce th is, however, by writing direct to t he prospectivecustomers bank but inviting them to reply via your bank, whosedetails should be included in your letter of enquiry (they will notreply direct to you). The alternative is to get your bank to handlethe entire enquiry on your behalf.

Tra de r eferences

Whilst it is unlikely that someone will give you details of a tradereferee (someone with whom he already has an account) whowould give a bad reference, it can still be useful to pursue this

information. A word of warning - if you do not recognise thename of the referee, check it out to see that it is a genuinecompany. Also, you should make it easy for the referee tocomplete your reference form and reply - busy people will not goto a lot of trouble to provide you with information following anunsolicited enquiry.

Your t rade reference form should be straightforward, with shortanswers or tick boxes to be completed. Q uestions could include:

% How long has the subject been known to you? Include spacesto fill in the number of years or months;

% How much do you normally allow on credit? Include a signwith a space after for the figure;

% What terms are allowed? Here you could leave a space forterms to be filled in, or provide a list t o be deleted or ticked asappropriate, including for example weekly, fortnight ly,monthly;

% Are payments made regularly and to terms? Yes/No, forreferee to delete as applicable; and,

% Have you any other comments you would like to make? Leavea space for the response.

It is usual also to add at the bottom a place for the referee to sign,along with a disclaimer along the lines of: This information isgiven in the strictest confidence and without responsibility onour part .


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Tra de Refer ence Enq uir y

1. How long has the subject been known to

you?

______mths/yrs

2. What amount do you normally allow oncredit?

________

3. What terms are allowed? Weekly Fortnightly Monthly Other (pleasestate) ____________

4. Are payments made regularly and to terms? Yes / No

5. Have you any other comments you wouldlike to make?

__________________________________________________________ __________________________________________________________ __________________________________________________________ __________________________________________________________

This information is given in the strictest confidence and withoutresponsibility on our part.

Signed...........................................................................................

For and on behalfof.......................................................................

Information from competitors

Some specific industries have established credit groups, to shareinformation; you should find out whether or not one exists inyour field. That aside, it is a good idea to develop relationshipswith your competitors - your customers may well be theircustomers, and the opportunity to share information is not to bemissed. As well as finding out if a potent ial customer appears tobe a good risk, you could also be tipped off if a customer lookslike they are in trouble.

Credi t r eportin g a gencies

For larger companies, you will be able to conduct a searchthrough, for example, Dun and Bradstreet. For smaller concerns,you may be better off checking the owner or a partner as aconsumer.

Compa ny inform ation

If you require more information, or if you feel the informationyou have amassed is contradictory or inconclusive, you could


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always ask to have a look at your prospective customers balancesheet. At the end of the day they must file accounts with thecompanies registry by law, so have nothing to lose by disclosure.Naturally, any information you are given must be treated in thestrictest confidence.

In all cases, ask yourself if a credit check is really necessary; aone-off sale of, say, 200 is unlikely to necessitate a credit check,although a request for monthly credit of, say, 500 or moreprobably would.

!! Credi t contr olWhen controlling your receivables ledger, it helps to have anestablished policy. That lets both you and your customers knowwhere they stand. The first step is to establish credit terms - net

14 or 30 days, for example, so that you know when collectionaction should commence. The two most commonly used methodsare reminder letter and/or telephone collection.

Remind er letters

Reminder letters must go out when the account becomesoverdue; say at around 40 days for a 30 day account , to give thestragglers a chance to get their payments in. It is not worthhaving a series of reminders, as people will get to know thesequence and wait for the last one before taking action. Haveone, and make sure it is specific and to the point.

Often letters have a sentence stating that you should ignore theletter if payment has already been made. Rather than doing that,ask people who have made payment to get in touch with thedetails immediately - after all, you do not want to give people theimpression that it is okay to ignore your correspondence.

Examp le: Remin der letter

Dear Mr Smith

Amount due 850.67

Our records show that the above amount is now overdue. Pleasesend us a cheque for the full amount to arrive no later than 25 th

July.

If payment has already been sent, thank you. Please contact uswith the details.

We look forward to hearing from you.

Yours sincerely

Teleph one collection cal ls

Before you pick up the phone to make a telecollection call, thereare a number of things you should do. It is essential that you


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prepare thoroughly, and that you are as prepared as possible forthe kinds of excuses for non-payment that you might be facedwith . Whilst it may not be possible to be prepared for everyeventuality, by making sure that you are informed and aware, youshould cope with the majority of situations.

Pre-call preparation

Before you pick up the phone to make a call, there are somethings you should know:

% How do things stand?: How much exactly does your customerowe? How old is the debt? Have any queries been raised? If so,have they been satisfactorily resolved?

% What has happened in the past?: How have they paid in thepast? Have they always paid late, but you have just noticedthe fact? Is their late payment this time a deviation from the

norm? Is th is an established customer?% To whom do you need to speak?: You need the name of the

person who can authorise payment. If necessary, make aseparate call to be sure the information you have is correct.

% What do you want to achieve?: What will make it worth yourwhile to pick up the phone? Set primary and secondaryobjectives. Your primary objective will generally be paymentof the account , in full, immediately. Your secondary objectivewill depend on the circumstances, but may be payment of allbut the current and/or any queried amount.

Mak ing the call

When you are put through to your contact , you should:

% Introduce yourself by name, to make the contact personal. If you have made a connection with someone on a personallevel, they will find it more difficult to lie to you or to shout atyou.

% Listen actively, and let the customer know that you arelistening. Remember to use listening noises, to repeat back information and to summarise the facts to confirm that you

have listened and understood.% Question effectively, to gain information and keep control.

Open questions are fact finders; they begin who, what, where,why, when, and how. Closed questions require yes/no answersonly; they are helpful to focus att ention on the facts and tocontrol the conversation. A good opening question to use isIs there any reason why this account cannot be paid in fulltoday? It requires a yes or no answer only; if the answer is yes,you can then go on to use an open question to get moreinformation, if the answer is no, the customer has no reasonnot to agree to make payment. (If you opened with, for

example, Why is it that you havent paid? then you are


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inviting an excuse - we need a copy invoice, this is in query, orwhatever.)

% Use silence to bring pressure to bear. After someone has beenasked a difficult question, they may need thinking time;alternatively, they could be on the hook. If you open with thesuggested question, then it is essential that you remain silentafterwards and allow the customer t ime to reply. If you break the silence and ask, for example, Did you get the invoice?then you are making the customers excuses for him! Dont,give him a little thinking time and allow the silence topressure him.

% Get a commitment to pay from the customer. After all, thatsthe entire point of the call. If you end without getting promiseof payment by a particular date then you are guilty of thesame error committed by the salesman who ends his salesinterview without asking for the order.

Deali ng wi th an gr y customers

The golden rule, when dealing with customers who are angry, isdont take it personally - its the circumstances theyre angrywith, or afraid of, not you. Let them get the anger out of theirsystem and then use open questions to establish what theproblem is. At all times you should avoid aggression; it neverpays off, as it isnt the way to get people to do what you want. Inaddition, it will terrify your honest customers and make noimpression whatsoever on habitual debtors. You must also beware

of being forced into making threats which are risky to followthrough into action.

Furt her action

Taking further action (legal action, for example) can beexpensive and also costs you the customer. However, there aresome habitual debtors who only ever pay on receipt of a courtsummons, and in such cases the appropriate action should betaken. Purchasing sanctions are often more effective when theyare at the back of the customers mind rather than being used. If sanctions are taken then the customer has an excuse to stop

talking with you, and it is generally easy enough to open up a lineof credit elsewhere. Beware of bluffing - once you have made athreat, you must either follow it through or else lose credibility inthe eyes of the customer.

Follow -u p a ction

You should always keep full call detail records, which shouldinclude:

% the date and t ime of the call;% who it was that you spoke to;

% the main points of the conversation; and,


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% when you should receive payment.

It goes without saying that you should always do what you saidyou would do, when you said you would do it. If you said youwould resolve a problem by Wednesday, then make sure you do;

if you said you would ring after seven days if no cheque wasreceived, then make sure that you make that call.

Paymen t dela y ta ctics

The four main reasons for late payment are:

% Inefficiency - common excuses include we are going ontocomputer, we are short of staff and so on. It can be helpfulto find out how the invoice approval system works; also, if youget the chance to meet the person responsible for passing theinvoices for payment, do so - the fact that they can put a faceto the name when they come across your invoices can often

speed the process up. Ultimately you must be tough with thesecustomers, but it might be worth being patient if the problemis short-term rather than endemic.

% Dissatisfaction - if the customer has a legitimate unresolvedquery, then ask for payment of all but the queried amount;you must, however, resolve the query as quickly as possible.

% Deliberate policy - there are some companies who set out totake as much credit as possible. Beware the ones who turn thesituation around and say all our suppliers give us 90 dayswhich t ries to shift the blame from their policy to yours. If youwere to investigate, you would probably find that 90 days wasbeing taken, but not necessarily that it had been agreed.Ideally you should refuse to accept such treatment, althoughin practice the response must sometimes be tempered bycommercial considerations.

% Cash flow problems - in many companies (perhaps includingyour own!) there is a pot of money available each month outof which bills are paid, and which is often smaller in valuethan t he total of the bills which are presented. Most of thetime th is just means that you have to wait an extra couple of weeks for payment, which often means that your creditors also

have to wait in the chain. In extreme cases, you could bedealing with a customer who desperately want s to pay you, butwho simply has not got the money to do so at the moment.Companies with cash flow problems will often tend to useexcuses like we need a copy invoice, we dont understandthe charges, we need a copy of the delivery note, and thatold chestnut, the cheque is in the post.

Let us move on now to consider some of the more commonexcuses offered by debtors for non-payment and some suggestedresponses.


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The cheque needs a second signature

This is a genuine requirement of some companies, but is used bymany others as a delaying tact ic. You can check if its genuine ornot by asking to speak to the signatory - if it is genuine, you willbe put through and can plead the urgency of the case first hand,if it is not , then your request will be refused and you will have toquestion further to find the real reason.

Well look into it and rin g you back

Bet they dont! Always be in charge of calls - use your initiativeand offer to ring the customer back at a pre-arranged time, or elsesay if you dont call me, Ill be sure to ring you. That way, theyknow that you mean business.

The cheq ue is in t he p ost

Possibly it is, but its more likely that it isnt. Ask for details -cheque number, amount, date sent, whether it was first or secondclass, if it was marked for anyones attent ion and so on. If it is inthe post, then youll get the information. If it isnt, you should getyour cheque promptly and - as a bonus - the excuse probablywont be offered again. If no cheque arrives, call again withindays, rather than weeks.

Your i nvoice is in t he comp uter f or p aymen t

If you are prepared to live with th is, fine. If you aren t, ask for amanually raised cheque. All companies can do this, althoughsome are less willing than others.

The p erson you wish to spea k to is not avai lable

This could be genuine, but if you find it is happening regularlyand you believe you are being stalled, escalate the call. Ask forthe managing director or the financial director - no one is tooimportant for you to speak to, and taking this approach showsthat you mean business.

Tha t in voice is in quer y

Ask for full details of the query, the name of the person dealingwith it, and payment of the undisputed amount . If the customerdigs his heels in, check out the query and see that it is resolved asspeedily as possible. Once all obstacles to payment have beenremoved, you should get your cheque.

Could you send a copy in voice?

A simple and commonly used tactic, and yet one which canprove difficult to handle. If they insist copies are necessary, faxthem if possible; write on the invoices th is is a bona fide copy

invoice, sign it and date it. That way if your customer then triesto insist that a fax is not a legal document, you are covered. If


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you have a customer who habitually asks for copies, considercharging for them; its not unreasonable, and if this is just adelaying tactic then it will stop. Alternatively, send the copies asa matter of course before making the call; that way youeffectively remove the reason for non-payment.

Our p ayment conditi ons ar e

Faced with this one, check the documentation just in casesomething was written in; at the end of the day, suppliers termstake precedence anyway, but being sure of your facts will standyou in better stead to negotiate. Check out the customerspayment terms and try to be added to their prompt payment list.

The person who signs the cheques is away from the office

This is often used as an excuse and delaying tactic. Try todetermine how long the absence is for and find out if anyone elsecan sign cheques (speak to them if there is someone). Press for apromise of settlement with a set date for action and call back if nothing is forthcoming (or call back at 9.00 am on the first daythe signatory is back in the office, to stress the urgency of thesituation). Ultimately it is illegal for a company to continue totrade when they cannot carry out their business properly;consider asking to speak to a director if you are gett ing nowherefast.

We are changing bank s

This can cause delays but is normally quite straightforward.Confirm the balance outstanding and take details of the newbank - suggest they apply for an emergency chequebook, if theydont have one already, or suggest that they use another methodof payment ; there is no reason why changing banks should stoppayments being made.

We are going through a re-orga nisation (or take-over)

Take an interest and show concern, that way youll get more

information about whats going on. Offer to call (or to have asales person call) when the changes are complete - and go for fullsettlement; they should be able at least to raise a manual cheque.

Do you want my business or n ot?

This is a particularly nasty form of blackmail, especially whenused against a small businessman by a larger concern. The bestway to deal with this sort of comment is not to rise to the bait butto say, of course we want your business, Mr Smith, you are avalued customer; but payment of the account within the termsagreed is all part of a business transaction. Extended credit has tobe paid for by someone and it would be a shame to see it reflectedin the customer tariff. Prompt payment enables customers to


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benefit from competitive prices and this would be affected if customers were to take unofficial extended credit.

We can t real ly say when it wil l be pa id

If the customer is completely evasive then it is up to you to try toestablish the real reason for non-payment. If the problem is ashortage of cash, then that is not just the customers problem, itis your problem too. Make that clear and then move on to seehow you can work together to sort things out and find a solution.If you decide to go for timed instalments, be specific aboutamounts and due dates. Be sure to monitor the situat ion andkeep t rack of your customers financial position.

The chequ e is received b ut wi th n o sig na tur e

Make a call to acknowledge receipt of the cheque and bear inmind that it could have been an oversight, but press hard foragreement on the date of receipt of the signed or replacementcheque.

!! Moni tori ng accountsTo help you to keep an eye on your debtors, it is necessary tohave a measurement system which allows you to compare monthby month what is overdue, and which would not be distortedwere you to have either an unusually good or bad monthsaleswise. A common way of doing this is to measure the days

sales outstanding. To do this, you assume all months have 30days and work out the average days sales.

EXAMPLE Total debtors at 31 May 15 000Less current sales (May) (8 000) = 30 days salesOverdue balance 7 000

Total of last months sales (April) 8 500

Overdue balance expressed as percent of last months sales

7 0008 500 = 82 per cent = 25 days sales

Total debtors = 55 days sales outstandingUsing this method of measurement, you can monitor yourdebtors. If the figure increases, you can bring some credit controlaction to bear. If it decreases following, for example, a telephonecollection campaign, you can measure the success of the act iontaken.

Many account s receivable ledgers follow the Pareto principle -that is, 20 per cent of the accounts make up 80 per cent of thedebt; consequently any action taken will be more effective if,rather than working through the ledger alphabetically, say, youprioritise your t ime by contacting the account s responsible forthe greatest amounts overdue.


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You must also recognise that keeping an eye on the days salesoutstanding alone may be to ignore a growing problem with longoverdue amounts. If you are collecting a good percentage of current or near current debt, then your days sales outstandingmay hover around the 45 - 55 days mark, with which you may be

happy. However, if the majority of those days is made up of accounts which have gone into 90 days overdue or more, thenyou do indeed have a problem.

The best way to combat this is to keep an eye on your aged debtanalysis. This will generally show you the account name (and ornumber) on the left-hand side and the overdue status - current,30 days, 60 days, 90 days or over - at the top. Neglected overdueaccounts end up on the right of the printout - t he more you havehere, t he bigger your problem with neglected debt.

The figures used in the examples come from the calculation of days sales outstanding example looked at previously. You can seehow in the top example, whilst there is perhaps a little cause forconcern with regard to old debt, things are pretty much undercontrol. The second example, however, tells a different story.There is a real problem with old, neglected debt, although muchmore success has been enjoyed in the collection of near recentdebt, masking the problem when looking at days salesoutstanding.

Consequently a collection programme must look not only tocollect sufficient cash to meet the collection target for the period,

but also at reducing the amount of overdues to a minimum -particularly if dealing with a known high risk account.

Aged Debt Ana lysis

Account Name Balance Current 30 days 60 days 90 days Over 90ABC 1 500 1 300 200Bloggs 2 000 500 1 500Cartwright 1 300 750 300 250Dobson 700 700Elliot 4 000 2 250 1 250 500Freeman 1 250 500 750

Green 1 750 1 200 550Higgins 2 500 800 1 000 700

Totals 15 000 8 000 5 550 1 450

Account Name Balance Current 30 days 60 days 90 days Over 90ABC 1 500 1 300 200Bloggs 2 000 500 450 450 300 300Cartwright 1 300 750 550Dobson 700 700Elliot 4 000 2 250 250 1 000 500Freeman 1 250 500 500 250Green 1 750 1 200 100 450Higgins 2 500 800 200 1 250 250


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Totals 15 000 8 000 1 300 1 100 3 000 1 600

!! Fur ther action

The period of credit a customer can take is largely up to you - aslong as you monitor your days sales outstanding (and aged debtanalysis) and are happy with the ratio. Irrespective of the lengthof credit terms granted (or taken) a sale is only completed whenthe money is received in payment. Too big an investment indebtors will result in a cash flow problem. When a customer doesnot pay, the bad debt becomes chargeable to the profit and lossaccount , and as the goods or services have already been supplied,then a company operating on a profit margin of 20 per centwould have to make a paid sale of five times the bad debt to putthe same amount of profit into the account.

Cred it insura nceCredit insurance is intended to provide reimbursement to acompany who, having supplied goods and services to a tradecustomer, find that the customer cannot pay. Very oftencompanies insure goods against physical perils (fire and flood, forexample) during the processes of manufacturing and selling.Without credit insurance, however, there is no cover once theyhave been supplied to a customer, despite the fact that the sale isnot safe unt il payment has been received.

It is also worth looking at your sales ledger to see if the Paretoprinciple does, in fact, apply; if a small number of customers areresponsible for the majority of your debt , you could be in adangerous position should one of them go bust. In thesecircumstances, credit insurance should be seriously considered. Itis not unknown for the insolvency of a major customer to causethe insolvency of a supplier, who in turn causes the insolvency of one or more of their suppliers - the domino effect.

Debt r ecovery

There will be times when despite your best efforts, your customersimply will not pay. In these circumstances, you need to be

prepared to take things a stage further. It helps if you keep youreyes open for the danger signs and a plan of action will help youto be aware of potential problem accounts.

Spotting the first signs of danger:

% keep your records up to date and in such a way that problemaccount s are quickly highlighted (aged debt analysis isparticularly helpful here);

% keep in regular contact with your debtors;% gather information on your debtors to give as clear a picture

as possible of their financial situation; and,


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% remember that if you have just organised your records,someone who looks like they may be in trouble may be justcarrying on as normal, except that you are now aware of theirpayment habits; dont jump to conclusions, check thepayment history.

When you reach the stage of needing to take action to recoveryour debt, either because communications with your debtor havebroken down or because it is obvious that they do not intend topay (insolvency is dealt with separately) then you have a numberof courses of action open to you:

% you can engage a debt collection agency to pursue the debt onyour behalf (normally a letter followed by legal act ion); or,

% you can make an arrangement with your solicitor wherebythey send letters on your behalf prior to legal action; or,

% you can call personally on your debtor; or,% you can take legal action.

Debt collection ag encies

In the first instance a letter will normally be sent informing thedebtor that the agency has been instructed t o recover the debt onyour behalf and requesting payment of the full amount duewithin seven days, after which legal proceedings will beundertaken. These are generally very effective, and the agencywould typically take a percentage of the sum recovered as theirfee.

The legal action stage can prove very expensive - check that it isworth your while to pursue a debt in this way, or be selectiveabout the debts you pass over and monitor what collection oneach is costing - there is nothing to be gained by collecting a debtof 500 if it costs you 550 to do so.

Solicitors

Most solicitors engage in a certain amount of debt collection andin fact some firms now specialise in that area. Be sure you areaware of the fees, and again, monitor debts to check they are stillworth pursuing.

Personal call

This can prove very effective as you will have the opportunity tospeak face to face and perhaps to collect t he sum owed, or at leastto check if the goods you supplied (if appropriate to yourbusiness) are in good order and might be recovered. It also givesyou the opportunity to have a look at t he premises and to gain aperception as to the state of the business: Are they still trading?Are t hey obviously in distress? Do they appear to have many

assets? Information gained could prove useful.


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Legal action

Legal act ion may arise for several reasons, including chasingunpaid accounts, breach of contract, personal injury and so on.The chasing of debts is a time consuming and often expensiveprocess. However, procedures with in the small claims courts havebeen issued to reduce the time and expenses required when smallclaims are involved. A small claim is one of 3,000 or less andthe majority of these cases are handled through a system of arbitration. Arbitrat ion is an information hearing of the casebefore a District Judge. It allows small claims to be dealt withquickly, cheaply and informally by allowing the creditor topresent his or her own case without the use of a solicitor. Wherelarger amounts are involved, most people will prefer to useprofessional representation in the courts.

Legal action should be seen as a last resort, when all other

avenues have been explored. Ask yourself three questions aboutthe debt:

% Have you tried every available option to resolve the matteramicably? Once the court proceedings have begun, and asummons issued, any customer relationship is most likelydestroyed.

% Does the debtor in default have no valid reasons for disputingthe claim?

% Is the person financially able to pay? Pursuing someone who isunemployed or living on a modest fixed income may be

pointless.

If you can answer yes to all three of the questions you shouldseriously consider taking court action. However, beforeproceeding you should advise the defaulter of your intendedaction, stating in writing that you will take court action if payment is not received with in the period of t ime you specify,generally seven days. This may provoke payment, but if the claimis disputed you should act upon your statement and t ake thematter further.

Procedures

It is a two-stage process to recover money through the countycourt. You must first obtain a judgement for the amount of thedebt. A judgement is legal recognition of the existence of thedebt and an order for the debtor to pay. Should the debtor notimmediately settle the debt, you may have to have the judgementenforced via one of the methods available through the court.

Obtaining a judgement

A default summons may be used to demand a specified amount of money, usually when one is seeking to recover payments forgoods or services, but can also be used when claiming fordamages, such as for injury or breach of contract, when the court


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will decide upon the value of the claim. You can start a claim inany county court, but if it is defended, t he case will beautomatically transferred to the defendants county court.

It is up to you to initiate the claim and identify the defendant in

question. Go to the county court and state that you wish to issuea summons for money owed to you. The court will give you adefault summons form which you must complete. You will needto decide whether you are suing a firm or an individual and if youare making your claim against more than one person, you willneed t o complete a form for each one. Forms are available freefrom the county court, but a processing fee will become due whenyou return the forms to the court. The amount of the fee isdependent upon t he amount of the claim and will be added to it,as it is recoverable from the debtor. If the action succeeds interestmay also be claimed on the debt. (Even if no contractualprovision was made for this, you can claim for statutory interestfrom when the debt became due to the date of the judgement.)

Small claims procedures are generally used to avoid the use of asolicitor or lawyer. However, if the defendant decides to employ asolicitor, then you are advised to do the same, although this costcannot be reclaimed from the losing party.

Enfor cing a judg ement

Obtaining a judgement does not guarantee that you will get paid,and the court will not enforce the judgement unless you ask it to

do so. Again, a fee is payable for this, which will be added to theamount to be recovered from the defendant. A choice of methodsis available and you will have to decide which is appropriate,taking into consideration the size of the debt, and yourknowledge of the debtor and his/her assets. Some proceduresinvolve only the completion of forms and paying the appropriatefees, others are more complex. The following options areavailable:

% Warrant of execution against goods - This involvesauthorising a county court bailiff or sheriff to seize and sellgoods belonging to the defendant to settle the debt and

associated costs. This is a commonly used method, but isgenerally ineffective because the resale value of the goods isoften low. In addition, certain goods are exempt from theprocedure, including items that are on rental or h ire purchase,items needed for the defendant to use personally in his tradeand necessary domestic items.

% Garnishee proceedings - You can request that the court ordera third party who owes the defendant money to pay thisdirectly to the court. Generally this will be a bank where thedefendant holds an account, but it can also be a customer of the debtor. You will need to know details of the account.

% Attachment of earnings - if the defendant is in regularemployment, this is the best method available to enforce the


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judgement. The court will order the employer to makedeductions from wages to sett le the debt.

% Bankruptcy or liquidation - if the debt is large (above 750)and the debtor is self-employed, the only way to obtainpayment may be through a bankruptcy petition. Thisprocedure is very complex and probably best left to aninsolvency lawyer. Winding-up or liquidation proceedingsare the equivalent to bankruptcy where the defendant is alimited company.

% Oral examination - if you need more information about thedefendants financial situation, you can apply to have him/herquestioned by an officer of the court. This may be useful toassist in the choice of enforcement methods.

Factoring

Factoring and invoice discounting are financial services thatassure continuous cash flow for a growing business. This servicecan be useful to businesses that need to speed up payment of invoices to provide working capital for the business.

A business approaches a debt factoring agency to apply to use itsservices. The factor, which may be controlled by a bank, willcheck the businesss credit rating, turnover, and customers,before accepting it as a client . In general, t hey will only acceptbusiness from companies with over 100,000 turnover per year.

Once they have accepted a client they will pay up to 80 per cent

of the value of an invoice payment due to the client. The balance- less fees and interest rates - is paid when the invoice paymentfrom the customers is received by the factor.

The factoring agency takes on the responsibility and financialburden of collecting payment from the businesss debtors andthus frees the businesss managers to focus more on the businesssprimary operations. The factoring company will charge a marketinterest rate and a fee depending on the level of service provided.

A variety of services are available from factoring companies. Themain ones: full-service factoring, invoice discount ing and exportfactoring, are outlined below.

Full- servi ce factorin g

In full-service factoring (sometimes called managed debtfactoring), the factor will assume responsibility for both the salesledger and credit management. Through a factoring agency, abusiness can expand their purchasing power without relying onbank credit. As a result, they can buy the goods they need,avoiding the normal delays that occur when opening lines of credit. The range of services available from a factoring agency

vary and can be tailored to meet the needs of individual


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companies. Generally, a client can choose from the followingservices:

% Non-recourse factoring - provides 100 per cent cover againstbad debt.

% Recourse factoring - in the event of bad debt the factor willrecover any advances from the client. The client can take outinsurance against bad debt. Some smaller, independent factorsdo not offer such insurance themselves, but will arrange forthis type of protection t hrough a trade credit insuranceagency.

% Confidential factoring - the factor will not disclose the use of its services to a clients customers.

% Collection of debts either by the factor or by the client onbehalf of the factor.

% Agreement for advance payments either to be based on wholeturnover or to be provided for debts as they arise.% Flexible finance geared to a businesss volume of sales.

Invoi ce d iscounti ng

Invoice discounting is a form of factoring in which the factorlends money to the business against invoices; the business isresponsible for collecting the debts itself. In an invoicediscounting relationship, the client sends the factoring companya duplicate of all customer invoices sent out. On receipt of theinvoice the factor pays the client up to 80 per cent of the value of the invoice. Once the customer has paid the invoice the clientrepays the amount of the advance, plus fees and interest. In sucha relationship the client maintains full control over the salesledger and is responsible for chasing slow payers.

A business will use invoice discount ing when it prefers to keepthe involvement of a factoring agency unknown to theircustomer. Invoice discount ing is most often provided by largerfactoring agencies because greater sums are involved. It is mostsuitable for larger companies with a turnover of at least 2millionwho need finance credit protection but not sales ledger

administration. Unlike standard factoring, it generally does notprovide for protect ion against bad debts.

Export factor ing

Export factoring is commonly used for companies trying tocollect payment from a foreign customer. A factor in the UK,known as an export factor, is held responsible for the client ssales ledger and for selecting a factoring agency in the country of the customer. This factor serves as the import factor and isresponsible for collecting payment from the customer and passingit on to the export factor.


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Business management

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Find ing a fa ctor

The Association of British Factors (ABF) provides a list of itsmembers with a brief summary of services offered, regional offices

and the approximate minimum client turnover. Alternatively,your bank manager will be able to advise you on a suitable localcompany, although since most banks now offer a factoring serviceit is likely they will offer their own services. Local companies arelisted in the Yellow Pages under Factoring.

Fees

A factoring company is paid for the service it provides in twoways, through interest payable on any sum advanced and throughfees for specific services.

Interest is typically 3 per cent over the bank base rate. The feesvary with the level of service provided. They range from 0.2 percent to 1 per cent of invoice value for invoice discounting andfrom 2 per cent to 3 per cent for non-recourse factoring. Thefactor may submit t wo types of charge to his client s:

% Discount charge. This charge is a discount on the purchaseprice of the debts (eg a deduction from the full face value of an invoice) - the factor does not pay the client the full value.The charge is usually comparable with overdraft rates.

% Administrat ion Charge. The administration charge covers thecost of debt collection and sales ledger administration. It will

usually be between 2.5 per cent and 3.5 per cent of the totaldebts collected.

!! Voluntar y ar ra ngementsA voluntary Arrangement (VA) is an agreement between aninsolvent business (ie one whose financial position is such that itsdebts could not be repaid as and when they fell due) and itscreditors. Such agreements allow bankruptcy or winding upproceedings to be postponed or avoided ent irely with the businesscontinuing to trade - as long as it continues to pay off its debts toan agreed timescale.

Three types of Voluntary Arrangements are possible, dependingupon the type of business involved:

% Individual Voluntary Arrangement (IVA) for sole traders.% Partnership Voluntary Arrangement (PVA) for partnerships.% Company Voluntary Arrangement (CVA) for Limited

Companies.

The VA route out of insolvency is still rarely used in comparisonwith bankruptcy and liquidation. IVAs account for around 10per cent of the number of bankruptcies, whilst CVAs account for


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around 2.5 per cent of liquidations. The principles behind thedifferent types of VA are essentially similar. If you believe thatthis would be the right route for you to take, more informationwill be available from the insolvency practitioner dealing with theparticular case under consideration.

!! Insolvency & l iq uid ati onTo be insolvent is defined by the Oxford Dictionary as beingunable t o pay ones debts. Companies who find themselvesinsolvent can endeavour to either wind up and liquidate thecompany or re-finance it and continue trading.

Faced with an insolvent debtor you should first try to identifyways to recover your money. It is important that lessons arelearned from such experiences, and so you should also look for

ways of avoiding recurrences in t he future.Recoveri ng your m oney

When a company has been declared insolvent you shouldmonitor the situation closely so that you may protect yourinterests. A creditors meeting will be called and you should benotified of the details and sent the necessary paperwork andproxy vote.

If at all possible attend the meeting and be sure to research thecompany beforehand - check out the information filed atCompanies House, for example. If you cannot attend themeeting, it is perhaps best not send your proxy in favour of thechair, who will be one of the directors of the insolvent companyand whose interests might not match your own.

Monitor the progress of the liquidation closely, part icularly withregard to assets and their realisable value. Remember that in thecase of a Creditors Volunt ary Liquidation (CVL) you are in abetter position to influence the outcome of the liquidation thanunsecured creditors of any other form of liquidation orreceivership.

There are considerations that apply to all types of liquidation:% Charging order/garnishee order - a charging order (costing

50) is taken on a significant asset owned by the debtor. It ispossible that the debtors bank has taken a first charging orderso that they may recover their funds, which effectively meansthat your debt may be paid out of whatever (if anything) isleft. A garnishee order is applied to the debtors bank accountand seeks to settles your debt directly from any funds held.Both a charging order and a garnishee order must have beentaken out t hrough the courts prior to the company becominginsolvent, but either will help your status in the hierarchy of debtors following insolvency.


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% Obtaining a lien on assets - if you are holding any assets of aninsolvent company then you can claim a lien allowing you tokeep the goods until you have been paid.

% Retention of title - if this is included in your normal terms andconditions of trading then you should visit the premises of theinsolvent company promptly to identify your goods. You willnot be allowed to take them and it is necessary to get theinsolvency practitioner to agree and sign an inventory of thegoods in question but they effectively remain your propertyand may not be disposed of by the insolvency practit ioner.

% Personal guarantee - personal guarantees are rarely granted,but if your products or services are sufficiently necessary tothe company in question, it is possible that you could beprovided with a personal guarantee of payment from thedirector(s) in the event that the company fails to make goodits debt. It is essential that you make sure such guarantees areproperly prepared, signed and witnessed.

% Payment from a third party - if a third party is involved in anybusiness you have conducted with an insolvent company, takelegal advice as to whether or not you are entitled to anyrecompense from them.

% Dealing with the new owner(s) - if the company has been soldand you provide a necessary or unique product or service, youmight be able to negotiate some form of compensation againstyour previous loss - remember to check out the new owners,though, as you would any new customer.

% Taking action under the 1986 Insolvency Act - since this actwas passed there is legislation (under section 214) that makesit possible under certain circumstances for creditors of limitedcompanies to be paid out of the personal assets of companydirectors. This relies upon wrongful trading having occurred,which means that the directors continued to trade after theyknew - or should have known - that the company wasinsolvent. Take advice to establish whether or not this may beproven.

Cutt in g your losses

There will come a t ime when your efforts to collect simply meanthat you are throwing good money after bad and at this stage youshould probably write the debt off and put it down to experience.The effect of this action may be minimised if you provide for apercentage of bad debt.

Affording debtors

There are a number of ways in which you can estimate anappropriate amount to provide for bad debt. Some of the morecommonly used methods are as follow:


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% you can assess each account individually and make anestimate of potential bad debt based on what you know aboutthe customer; or,

% you can look at your aged debt analysis and, based on pastexperience, provide for a percentage of debt over a certainage; or,

% you can, if your ledger follows the Pareto principle, take outcredit insurance.

!! ConclusionEffective credit management is essential if you are to succeed inbusiness. Limiting the risk to which you expose yourself andkeeping an eye on t he performance of your debtors are simple buteffective ways to ensure that you remain solvent. Monitor your

days sales outstanding and your aged debt analysis, network withother companies and share information, and act promptly shouldthere appear to be a problem.

!! Useful addresses% The Institute of Credit Management, Easton House, Easton-

on-the-Hill, Stamford, Lincolnshire PE9 3NH.

% The Association of British Factors, 1 Northumberland Street,London WC2N 5BW, Tel: (0171) 930 9112.

% Companies House, Crown Way, Maindy, Cardiff CF4 3UZand for Scotland, 37, Castle Terrace, Edinburgh EH2 3DJ.

% CCN Systems Ltd, Talbot House, Talbot Street, NottinghamNG1 5HF.

% Dun and Bradstreet Ltd, Holmers Farm Way, High Wycombe,Buckinghamshire HP12 4UL.


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Assign ments, business plan s and NVQsHave you completed the assignments related to this book? We hope you have, because then you willhave a personal action plan which will assist you in identifying and completing your own developmentneeds. Whilst that is not essential for your business plan, potential funders will be looking for yourweaknesses. Demonstrating that you have not only identified them but are also addressing them willinspire more confidence in you as a business person. Completing the assignments will provideconsiderable evidence for elements of the NVQ as indicated, although it is possible that your assessormay require further evidence in support.

The aut horsProject North East is an enterprise and economic development agency whose purposeis to develop and manage innovative, quality services which offer individuals andorganisations the opportunity to realise their potential primarily through the creation

and development of business enterprises. Project North East has been writing and running trainingprogrammes for people starting in business since 1985 and has been providing further assistancethrough intensive counselling and through the use of assignments designed to help clients preparebusiness plans which demonstrate viability and determination.

Shell Live WIRE, managed by Project North East and sponsored by Shell U.K.Limited, is the national organisation which encourages young people to

consider starting their own business as a realistic option and, for those people who wish to pursue thatoption, it provides support and assistance from start up through to early growth. In all the services itprovides, Live WIRE stresses the importance of regular planning, whether formally or informally, as a

major requirement for success in running a business.


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effective credit management_timothy mahea

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