Business mentor: Bad debt can leave you high and dry

Q: How can I improve my credit and debtors management?

A: Robin Rainbow, of outsource debtor managers Accounts Receivable Solutions, replies:

Giving credit is so risky most banks value debtors at only 30 to 50 per cent of book value. They can even be reluctant to place any value on your debtors at all.

This is hardly surprising when there is a 2 per cent bad debt risk the moment you give credit and a 25 per cent default risk at 90 days.

Businesses that sell to other businesses must give credit simply because their trade rivals do - but you end up giving customers interest-free finance.

As the New Zealand average payment time is around 60 days, you can be owed around two months' sales.

If your turnover is $1.2 million a year, it is possible your customers owe you $200,000.

Most New Zealand businesses selling on credit hope to be paid on the 20th of the following month. Clever customers know that if they buy from you on the 1st of the month they only need pay you 50 days later - ie, on the 20th of the following month.

Giving credit increases your working capital burden and when adding this to inventories, plant and equipment it means a lot of money is tied up.

This makes life hard for new start-ups and lack of financing can kill a business idea before it gets off the ground or send an existing one out of business.

If you have to give credit, then you should manage your debtors very carefully.

First of all, ask yourself, do I have to give credit at all? Ask your professional adviser, accountant or bank manager if it is feasible.

If you are exporting you should not be giving credit, but if selling within New Zealand you may have no option.

Attempts at eliminating it have been tried but most fail, such as cash discounts. With regular customers, these have a habit of backfiring: "I have forgotten the cheque book but will post it tonight" - and then never do but still deduct the discount when they do eventually pay.

Eftpos or credit card payments are usually not appropriate for business-to-business sales either.

When giving credit, you have four basic options:

* Just muddle along like you have always done.

* Live on your bank overdraft, if you have one.

* Factor your debtors.

* Outsource your debtor management.

Just muddling along can mean poor use of your money, high interest costs, bad debt risk and being your customers' interest-free financier. The risk is it could send you out of business - what would happen if your biggest customer went bust owing you three or more months' sales? It often takes businesses three months or more before they cut off a late-paying customer's credit.

Financing your customers through your bank overdraft, if you have one, means the interest bill hits the bottom line.

Because banks regard trade debtors as high risk and also reduce the security value of other assets too, most are very reluctant to grant overdraft or other credit facilities to small or medium sized businesses without personal securities from the owners, directors or shareholders. They often insist on first mortgages on real estate.

Unless the business owns its own premises, this means the owner's homes have to be pledged as security.

If you want quick cash, factoring your debtors is an option. Major factoring companies offer a range of options that give businesses 80 per cent of the face value of their debtors immediately and the balance when the debtor pays them.

However, most factoring is with recourse. This means if the debtor fails to pay the factor, then you have to refund the amount advanced to you.

Outsourcing your debtors admin is another option. If you don't have qualified staff or the time to do it yourself, then look at outsourcing.

Whatever you choose to do, at least do something. Carefully manage your debtors as they can send you out of business.

* Robin Rainbow is CEO of outsource debtor managers Accounts Receivable Solutions (NZ), tel (09) 292 9057, email robin@credit-co.com or Accounts Receivable Solutions

* Send Mentor questions to: ellen_read@nzherald.co.nz Answers will be provided by Business in the Community's Business Mentor Programme.