Profitable Customer Relationships
Start with Good Credit Management
Canadian Business Franchise
Published Sept/Oct 2005
Many franchise owners spend a lot of time cultivating customer relationships. You may have to find prospects, convert those prospects into customers. Sell those customers more products or services.
After all that hard work, wouldn’t it be a shame if the customer doesn’t pay you?
Unfortunately, this happens all too often. It’s not enough to make the sale and deliver the product. You also have to collect the cash. Obviously, you want to win sales and in order to be competitive, many franchisees must offer reasonable credit terms. But if you don’t get paid when you’re supposed to be paid, your business could face a cash flow crisis.
If you want to ensure that your sales convert into profitable customer relationships, you need a reliable credit management system. There are two key components:
- the right policies and procedures, and
- careful control and monitoring.
The Right Policies and Procedures
Before you extend credit, you need to ensure that your business can afford to do so and you need to minimize your financial risks. This requires developing formal credit policies and procedures.
Prepare a Cash Flow Forecast
If you extend credit to customers, you should know how much working capital you require and how much money you can afford to have tied up in accounts receivable. Then you can develop a credit policy that won’t strain your cash flow.
The best way to do this is to prepare a cash flow forecast. This document estimates the amounts and timing of cash you expect to flow into and out of the business over the coming year. A cash flow forecast typically calculates cash on hand, anticipated receipts and expected disbursements. Preparing this forecast will enable you to budget the cash needs of the business over a period of time and to balance this with the credit needs of your customers.
Develop a Customer Credit Policy
Equipped with a good understanding of your expected financial situation for the coming year, you can develop appropriate credit policies for your customers. You can have a blanket policy for all customers requiring credit or adjust your policy according to the specific organization and situation. Either way, prepare a written document that specifies:
- The amount of time the customer has to pay (i.e. seven days, 30 days, etc)
- Acceptable forms of payment (i.e. cheque, credit card, etc)
- Consequences of failing to meet credit terms (e.g. work or shipments will cease, you will have the right to repossess shipped goods, etc)
- What late fees will be imposed and under what circumstances (e.g. interest of 3%/month will be charged on accounts not paid within 30 days)
- The customer’s responsibility for any legal fees or collection costs incurred.
Review this policy with any of your employees who may be required to administer it. Provide it to any customers requesting credit and ensure that they accept the credit terms outlined in the policy.
Create a Credit Application
If you are extending credit to a customer, you need to be sure the organization is a good credit risk. The first step is to gather the information you will need to check on the customer’s creditworthiness.
Develop a credit application that will enable you to capture the appropriate information; this includes:
- Name of business (including complete legal name)
- Business coordinates: address, phone, fax and e-mail numbers
- Names, titles and addresses of the principal(s) of the business
- Type of business (proprietorship, partnership, corporation)
- History of business bankruptcies
- History of personal bankruptcies of principals
- Bank references
- Trade references (at least two other companies with which this customer does business)
- A clause stating the your company has the right to investigate the customer’s credit
- A clause stating that the customer agrees to abide by the terms and conditions set out on your invoices
- A personal guarantee that the business owners promise to pay you in the event that the company cannot
To ensure that this contract will be legally enforceable, should it be necessary, ensure that it is signed by a partner or officer of the customer’s organization who has the authority to enter into this type of contract. Also, ask your lawyer to prepare or review the document so that it is legally current and correct.
Conduct Credit Checks
After your potential customer has completed your credit application, you need to verify the information provided.
Follow up on bank and trade references. You can also contact D&B Canada or a credit bureau to get a credit report on the organization and the individuals who own it. Since the information that credit bureaus provide is not always completely accurate or current, you may also want to contact some of the other organizations with which this prospective customer does business. Or, you might try to contact an association that operates in the customer’s industry sector to determine if it provides any credit information.
If the dollars involved are substantial, visit the customer’s place of business; you can determine a lot about the health of a business by seeing the operation.
Offer Reasonable Credit Terms
While you may determine that an organization is creditworthy, it’s important to keep in mind that financial situations change often – both yours and your customers’. Therefore, to minimize risk, offer the minimum acceptable credit period.
Also, to encourage timely payment, consider offering a discount for early payment as an incentive.
Careful Control and Monitoring
While having proactive credit policies in place prevents many payments problems, it’s not foolproof. You also need to implement a vigilant control and monitoring system.
Review Accounts Receivable
Your credit management system should include a way of tracking accounts receivable. An aging accounts receivable report, for example, documents which accounts are past due and by what amount. If you review this report at least every month, you’ll have a timely perspective on any accounts that are becoming problematic.
Act Quickly on Late-Paying Customers
The quicker you act on an outstanding account, the better your chances of getting paid. Whenever possible, issue monthly account statements; these provide both parties -- you and your customer – with an up-to-date picture of the payment situation.
Inevitably, you’ll have some late payments, so it’s important to establish a system for collecting these; here are some suggestions.
- Enforce late payment penalties by charging interest as specified in your customer contract.
- Act on overdue accounts immediately. Send a reminder invoice marked “second notice” or “payment overdue.” If this approach doesn’t generate immediate payment, contact the customer by phone; consider offering payment options, such as:
- a discount for prompt payment,
- payment by credit card, or
- partial payment now with the balance on a mutually agreed payment plan.
- If the customer still does not pay you, immediately cease delivery of products or services. Then, become a nuisance. The “squeaky wheel” often gets paid first. Be the “squeaky wheel” – call the customer frequently and request payment.
- Retain copies of correspondence and record notes of telephone conversations. Confirm conversations in writing and try to secure the customer's written agreement to a promise of payment.
- If you still receive no response, ask your lawyer to send a "demand letter" stating your intention to sue if the customer does not provide payment by a specified date.
If the customer still does not pay, be prepared to sue; many debtors will pay when they receive court papers. But before going this “last resort” route, you should be certain that the relationship does not offer you any future potential.
Successful businesses are the result of enduring customer relationships. Ensure that your relationships are profitable by starting with the right foundation -- a reliable credit management system.
Rick Chittley-Young, CGA, is a principal of BDO Dunwoody LLP (www.bdo.ca). One of Canada’s leading accounting and advisory firms, BDO helps entrepreneurs, family businesses, franchisors and franchisees succeed. If you have questions about this article or would like to receive BDO’s “Tax Factor” newsletter, contact Rick in the Oakville office at (905) 844-3206 or rchittley@bdo.ca.
