In an increasingly strained economy, what are some of the top credit management tips for small businesses?
Growing a business in a strained economy is tough. Getting paid by your customers in a strained economy is even tougher. With the economy having contracted by 3,2% in the first three months of this year; April liquidations up by 53,1%; and business confidence at some of its lowest levels since 2011, there can be little doubt that the South African economy is strained. Businesses that sell their goods and services to other companies on a trade credit basis are specifically under pressure as they face the prospect of limited growth, coupled with cash flow consequence of ongoing payment default.
To adjust to this new reality, businesses (especially smaller ones) have to quickly adapt their thinking to survive this pressure or face the possibility of becoming part of the statistics. But how do businesses adapt? What must business owners do to adjust to the current economic pressure, and how does a business survive the tough times?
According to the specialist credit management company Debtsource, the top tips for surviving the cash flow consequences of payment default in this climate include:
Forget about the notion of blue-chip debtors
There are so many large businesses, SOE’s and even listed companies that are in financial distress right now, that the whole notion of blue-chip companies that always pay their accounts on time is gone. Some of South Africa’s biggest businesses that have been in existence for decades are no longer good credit risks, and businesses need to adapt to this reality. Previously companies could happily trade with these large debtors without security, and with no concern over being paid on time, but this reality has shifted. Every debtor, however small or large the company may be, and irrespective of who their shareholders are, needs to be treated with the same circumspection and diligence.
Insure your debtors
Credit insurance protects businesses against the possibility of debtor default and is an extremely effective tool for mitigating credit risk in any business. Smaller businesses that don’t have the depth in their balance sheet to sustain large bad debts should be insuring their clients in this economy, as a way to transfer as much of the credit risk to the insurer as possible. To be clear – not all of the credit risk in a typical debtors book can be transferred to insurers, and therefore it is vitally important that businesses still apply their own risk assessment and due diligence before extending credit facilities. South Africa has a vibrant credit insurance market in which it is possible to place a large percentage of the credit risk a business faces and it is highly recommended that companies consider this option.
Don’t rely on business rescue or liquidation procedures to save your bad debt
In any business rescue or liquidation scenario, creditors rank according to priority based on when they extended credit and the extent of any securities they may hold. Typically, smaller businesses which do not hold any security rank as “concurrent creditors” when their debtor goes into business rescue or liquidation. This is an important factor to consider, as concurrent (or lowest ranking) creditors hardly see much in the way of a dividend when their customer files for rescue or is liquidated. Moreover, the current statistics show that only 13% of companies that go into business rescue are ultimately saved in one form or another, but this does not mean that those businesses are saved by concurrent creditors being paid all their money. On the contrary, businesses are typically saved only by creditors writing off sizable portions of their debt owed. If you are a concurrent creditor you’ll hardly see more than 10% of your money back, meaning that you have to do everything within your control to pick the right debtors to sell to and then to negotiate very smartly if your client runs into cash flow difficulties.
Very few businesses historically have failed while having a healthy cash flow which is supremely dependent on customers paying their accounts on time. Getting customers to pay their accounts on time in a really challenging economic environment requires maximum diligence in managing such debtors and requires businesses to adapt their processes and attitudes to the realities of the market conditions.