Category: Finance

Why overdue debtor levels increase during times of economic growth, and 3 steps management can take to avoid the negative consequences.

It’s a little known credit management fact that outstanding debtor levels increase during times of economic growth!

But 3 credit and debt collection practices can keep cash-flow strong and reduce business risks.

Introduction

Managing working capital is vital in both periods of economic growth, and many countries such as Australia are forecast to enter a period of economic growth.

Cash flow stresses on businesses are caused by management getting distracted away from credit management during, and immediately following, periods of change in economic growth.

Outstanding debtor levels increase in both situations of economic slow-down and economic growth, and the negative effects are many – working capital comes under significant pressure, bad debts increase, paying your own bills becomes difficult, business risks increase.

Businesses should review their credit policies and increasing management focus on collections early in a shift to economic growth to prevent an impending increase in outstanding debtors.

Debtors increase during slow-downs, and during growth

The importance of tight management of cash flow and outstanding debtors during economic slow-down is widely known. Debtor payments slow down and bad debts grow during periods of decline in economic growth, as debtors’ businesses suffer from falling sales and cash flow difficulties.

Less well known is the fact that overdue debtor issues are also significant during economic growth. In both cases management tends to respond behind the curve, when the problem has already developed:

• As economic slow-downs start to hit, typically management’s first response is to tackle the immediate and obvious symptoms of the slow-down, such as falling demand and falling sales.
By the time management turns to chasing outstanding debts, the debtors are struggling with their own problems caused by the slow-down, and collecting the much needed cash is difficult and can be expensive.

• During periods of increase in GDP growth, typically attention also diverts away from credit management, to the immediate and attractive pressures of increasing sales and the requirement for increased production and delivery.

By the time attention turns to collecting outstanding debts, management finds that credit has been extended to debtors who are not creditworthy, and too much credit has been extended to other debtors, so collecting the much needed cash to fund growth is a slow and laborious drag.

Practical steps to take in advance

The good news is, there are practical steps management can take in advance, to protect their working capital and margins, for periods of growth and slow-down. Here are 3 steps to keep the cash rolling in and avoid unhappy business risks:

1. Review credit policies
• Set value and timing limits on all customers’ credit. E.g. no more than $20,000 credit, and no more than 30 days overdue.
• Are credit checks made on all new customers?
o Check each new customer and set credit limits accordingly
o Catch slow payers early – make a diary note to review the payment pattern of each new client 90 days after their first purchase – ask slow payers to pay up to date and stay current – restrict further credit until paid up to date.
• Regularly refresh credit checks on existing customers who pay late, and review their credit limits according to credit check results.

2. Increase collection speed and effectiveness
• Follow-up all outstanding accounts quickly to help Debtors to learn that they might be able to pay other creditors late, but they must pay you promptly.
o Treat terms of trade as a fixed requirement, not a flexible guideline
o Follow-up non-payment immediately its overdue
o Apply a short-cycle follow-up regime, e.g. at 14 days a reminder, 7 days later a Final Notice, 7 days later a legal Letter of Demand.
• With persistent late payers:
o Send a reminder letter one week before the account is due for payment, reminding the debtor that payment is due in a week.
o Send an overdue notice, email, or phone call, 2 days after debt is due for payment.
o Send a Final Notice, 14 days after payment is due.
• Act quickly to get priority payment:
o Debtors priorities their payments according to which creditor chases them most firmly.
o They usually pay Debt Collection Agencies before other creditors.
o Get priority payment of your debts by engaging a Debt Collection Agency early, to get your troublesome debts paid first.
• Switch to a Debt Collection firm that:
o Offers free advice to resolve tricky debtor situations.
o Provides Final Notice letters on their letterhead, which you can send directly to debtors, for zero debt collection commission on payments.
o Has no fee-per-letter for sending demand letters on their solicitor’s letterhead.
o Charges a flat-fee commission, around 10%.

3. Make credit review a regular priority focus
o Businesses benefit from making credit review part of their regular operating rhythm.
o Monthly review is too low frequency – daily or weekly management focus on outstanding debtors is best practice.

Summary

Australia is forecast to be entering a period of economic growth. During economic growth, credit policy and collection disciplines tend to loosen, which results in excessive working capital being tied up in outstanding debtors.

Loose credit policy and collection disciplines cause cash flow pressures that constrain funding for growth, cause increased bad debts and introduce more significant business risks.

There are actions management can take to prevent an increase in outstanding debts and to collect outstanding debts more quickly and effectively.

Management should consider taking those actions now, in advance of the growth forecast.