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More 'complete approach' to credit management needed

Cinque's Stefan Schoeman writes for Business Day's Credit Management Insights

During an economic upturn the credit department of a business is often viewed as a necessary evil, especially by the sales department. However, during a prolonged downturn such as the one SA is experiencing at the moment the true worth of a credit department comes to the fore.

Stefan Schoeman, director at Cinque, says it appears that it is somewhat of a perfect storm as far as credit risk is concerned.

“Inflationary pressures, the drought experienced in certain areas of SA as well as pressure on economies both local and abroad all contribute to increased credit risk. Increased pressure on cash flow also makes the benefits of economic fraud more attractive to those inclined in such a way."

“Merely creating an accounting provision for bad debt or taking out a trade credit insurance policy is not proactive enough to ensure good credit risk management. A more complete approach is necessary to prevent losses due to bad debt and to ensure the prompt collection of all trade debtors due and payable,” Schoeman says.

He says in the first instance — when deciding to offer terms to business customers — it is crucial to know the customer the company is dealing with as independent verification of a business’s details and confirmation of orders are needed.

How the business pays its other suppliers and the size of credit limits required compared to the size of limits with other suppliers are other important pieces of the puzzle. In addition to confirming details of the customer and establishing credit worthiness from the beginning, companies also need to be made aware of any adverse changes to the status of the customer which may affect further trading with the customer.

“Once the vetting is completed a decision needs to be made on how possible bad debt is to be provided for. It could be done on balance sheet via a provision or via a credit insurance policy."

“Interestingly, despite the economic environment which one would think has a detrimental effect on the cost of trade credit insurance, premiums on trade credit insurance policies are surprisingly competitive. This is predominantly due to two new entrants into the credit insurance market over the past two years and the resulting competition placing downward pressure on rates,” Schoeman says.

He notes that bad debt can be as a result of a debtor not being able to pay due to cash flow problems, instigating business rescue or insolvency, alternatively as a result of fraud or disputes.

“Cases where an ‘honourable’ customer is unable to pay are fairly straightforward. However, situations where fraud is involved are trickier. In many instances, losses due to fraud are the result of employees being complicit in the fraud. Internal controls play a big part in preventing such cases but one can also take out insurance against fraud to protect oneself against financial losses. Cyber-related fraud is becoming more prevalent and there are specific insurance policies catering for this eventuality.”

He says in the third instance, taking prompt action when a debt is overdue is crucial in ensuring the eventual collection of amounts outstanding. Arrear debts tend to clog up the system because the interaction with the arrear debtor can be confrontational and follow-ups and correspondence generally fall outside the system driven environment. Collections documentation such as final demands and acknowledgement of debt needs to be correct in terms of legislation to ensure the company is able to legally enforce a payment due.

“For these reasons it often makes sense to make use of a specialist third-party collector who has the systems to ensure prompt follow-up action, correct documentation and experience to know when to pursue the legal collection process,” Schoeman says.

He says the severity of economic downturns and the short time and unpredictability between their reoccurrence have clearly made proactive credit management a necessity.

“The key is in reducing the predictable bad debts and at the same time minimising the severity of the unpredictable bad debts. Tying the all the components addressed above together into a credit management strategy is the best way of protecting a business against financial losses due to bad debt.”