Good credit management is an essential component of running a successful business, and requires the implementation of a consistent and effective credit management policy, writes DEAN FRITH.
It is important to take proactive measures in managing credit facilities, especially in difficult financial times such as these.
By observing these five guidelines to establish a credit policy, you can proactively address potential issues and more effectively manage credit facilities within the business.
1. Establish terms of trade
It is essential that terms of trade are established and understood by your customers prior to supply.
These terms should preferably cover:
- the issue of price
- terms of payment
- warranties and conditions of purchase
- limitation of liability
- interest/administration fees
- costs recoverable
- security for payments
- what constitutes “default”
- what constitutes termination of the agreement
In order to most effectively protect the business in the event of a dispute, the terms of trade should be signed and dated by the customer to show their acknowledgment and agreement to those terms.
Depending on the type of business that is being carried on, specific conditions may be required in addition to these basic terms, and in such a situation, obtaining legal advice specific to your needs is advised.
2. Thoroughly assess customers and use a credit application
Conducting an accurate overall assessment of customers to which you will be providing credit is crucial.
You should insist on trade references, and then proceed to call the referees provided, in order to ascertain the customer’s likelihood of being a relatively safe credit risk. Once this has been established, it is recommended to provide your customers with an Application for Credit document.
Initially, this form should request the customer’s basic details, such as:
- Full legal name of the entity
- Type of entity i.e. sole trader, partnership, company, trust, government authority
- Details of the legal owners of the business or company
- ABN or ACN if applicable
- Physical address/Place of business
- Postal address
- Relevant telephone numbers (for business and after hours)
- Email address
By clarifying who the actual customer is in the initial stages of the supply, the business can more effectively enforce the collection of outstanding payments if the customer were to go into default. Therefore, the more information gathered about the customer from this process, the greater chance of securing payment for supplies in the future.
It may also be necessary to obtain or confirm business or company information by conducting Australian Securities and Investments Commission (ASIC) searches.
Ideally, in addition to sufficiently identifying who the customer is legally, the credit application form should also:
- Allow you to assess the customer’s ability to meet their financial obligations
- Allow you to undertake credit reports pursuant to the Privacy Act 1988
- Disclose your terms of trade
If you need assistance with this vital step of credit management Baker Love Lawyers has vast experience in drafting Application for Credit documents for a wide range of businesses.
3. Use personal guarantees and secure your debt
The incorporation of personal guarantees in a credit application may be effective to recovering a customer’s debt successfully.
The guarantee should ideally be drafted by a solicitor in a document of reasonable scope to ensure the likelihood of enforceability.
Guarantees should also be required to produce evidence of their personal ability to pay, such as providing financials.
In addition to obtaining information on guarantees, it is also important to secure your debt with a properly drafted “Retention of Title” clause in the terms of trade and registration of your security interest on the Personal Property and Securities Register (PPSR).
A registration on the PPSR will provide added protection in proving and enforcing your security interest against the customer in the event of default of the terms of trade and the customer entering administration or insolvency. This may set your debt apart from other creditors and increase the likelihood of receiving payment.
4. Establish a system
Once a risk assessment of the customer has been conducted, their ability to pay has been satisfied to the required extent and the terms of trade are finalised, it is important to establish an effective system to manage the payments.
By creating a system that consistently monitors invoicing, collection and follow up, a business is more likely to obtain regular repayments and sustain cash flow.
It is also essential to monitor any extensions of credit to customers, and to remain firm in not extending credit beyond reasonable limits based on the customer’s assessment.
If outstanding debt arises, it is important to have an established approach in managing the overdue payments.
When there are administration errors or cash flow problems, you must set a firm time-frame in which the payment can be expected. Furthermore, businesses should avoid making special payment arrangements for customers, as these can often backfire and leave your business financially vulnerable.
5. Have an enforcement plan
It is essential to have an enforcement plan to collect bad debt. Initially, this plan should involve issuing reminder and collection letters and telephoning customers at scheduled intervals. It may also include entering into an agreement with the customer for payment to be made by instalments.
If there is still no payment, then you can consider enforcing payment by the terms of trade. This may involve instigating debt recovery proceedings.