Offering credit and managing risk
Offering credit often encourages customers to speed up or increase the amount of their spending. Some businesses offer credit to gain a competitive advantage in their market. Balancing the potential for increased sales with the risk of reduced cash flow is an important part of managing risk in your business.
Depending on the nature of your business and size of transactions, you may choose not to automatically offer credit to new customers. Before offering a credit option, consider the following.
Risks involved in offering credit
- Reduced cash flow - you may wait for customer payments, which reduces your ability to purchase replacement products from suppliers. Many businesses consider debtor finance to reduce this risk.
- Reduced profit margin - funding credit sales reduces your profit margin. Usually, the cost of this only shows up in your profit and loss statement, so you need to keep this in mind when you are pricing your products and services.
- Large debts - unpaid debts can pose a risk to your business. This is particularly true if you are exposed to large single transactions.
Perform a credit check
A credit check is one strategy you can use to manage the risk of bad debt. Before you offer a customer credit, have them complete and sign a credit application form or agreement.
What to collect from individual customers:
- a signature confirming that they have read and understood all terms and conditions and have agreed to abide by them
- identification and contact details
- approval to conduct a credit check where necessary.
What to collect from business customers:
- comprehensive details of all directors, partners or owners
- at least 3 trade credit references
- signature of the applicant to ensure they have read and understood all the terms and conditions and have agreed to abide by them.
A deed of indemnity and guarantee for corporate clients is an option - it is an excellent safeguard against solvent clients. Ask your legal or financial adviser for advice.
Decide whether to offer credit
The final decision to offer credit should be based on all the data collected, in particular:
- the references
- for businesses, the length of time they have been operating
- guarantees signed in full.
Applicants should be required to authorise other company employees permitted to use credit on behalf of their company. You should have a policy about how your business customers can authorise other people from their business to use their company's credit.
Provide a prompt written response
After receiving a completed credit application, provide a written response approving credit, declining credit or requesting further information.
The response should specify:
- the amount of credit given
- credit terms
- guarantors (including guarantee forms)
- penalty and default terms
- any other terms and conditions.
Keeping records of debtors
Use a good filing system to keep track of customers who owe you money. This will help you follow up overdue payments and control your cash flow.
Download our sample debtors and creditors analysis table to see the impact of debtors on your cash flow.
Tax law requires you to keep a record of your debtors. Good record keeping helps you to better track and manage your debtors. The Australian Taxation Office (ATO) also requires you to keep records of your debtors and creditors.