8 December 2021

What to consider when giving credit



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Risks of offering credit & several strategies you can employ to mitigate those risks.
Australia Finance and Banking
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While offering credit is a valid way for your clients to increase their customer base and the demand for their goods and services, it is important as their advisors to remind them to manage the risks of offering credit and how this can affect their cash flow and their solvency.

There are several risks business owners/directors must consider when deciding to offer credit. The two primary risks are as follows:

  • Reduction in liquidity which in turn, may affect a business's ability to pay its debt as well as purchase required assets or invest in new products or processes.
  • Permanent loss of revenue if a service or product is provided to a recipient who doesn't have the ability to make payment. This is quite common in industries such as construction where significant time is invested and a service is provided before payment is made

There are several strategies business owners/directors can employ to mitigate the risks of offering credit in order to take full advantage. These include:

  • Having a stringent credit application process that may include performing a credit check or asking for references. Other investigations may include completing an ABN Lookup to confirm business registration, obtaining relevant guarantees such as personal guarantees from company directors to ensure payment, and obtaining a history of cash sales.
  • Setting and reviewing appropriate credit limits dependent upon the customers' risk profile, reducing the risk of losing large amounts.
  • Communicating clear credit terms on all invoices and promptly following up customers who exceed these terms. Standard terms of credit are often seven, 30 or 45 days.
  • Keeping up to date and accurate records of your debtors list. Inaccurate master records and invoicing can adversely impact the recoverability of your debtors; for example, if invoices are not being sent to the correct address or do not reflect the correct payment term.
  • Providing incentives to customers to pay on time.
  • Keeping payment terms for customers shorter than those with your suppliers to help maintain a healthy cash flow.

On the flip side...

For your clients who are creditors of big business (over $100m), the new reporting under the new Payment Times Reporting Scheme (PTRS) commenced 30 September 2021. Under this new legislation, transparency on payment practices is increased with these businesses required to report the payment terms they offer to suppliers every six months. This aims to eliminate cash management activity that disadvantages SME businesses that engage with large companies.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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