The Definitive Guide to Trade Credit Management Using the Seven C’s of Credit By Dave Birch from smartAR on Mar 4, 2016
Who doesn’t love a bit of Shakespeare? One of my favourite lines is from Hamlet:
Neither a borrower nor a lender be, for loan oft loses both itself and friend,
Whatever your business, if you advance credit to customers you are a “lender” of sorts. Clients are the equivalent of “friends” – often hard to acquire and best treated as precious assets. This article explores how to ensure any credit advanced by your business is repaid and the client bond is thereby enhanced, rather than strained, by the credit relationship.
Many readers will be familiar with the five C’s of credit – Character, Cash Flow, Capital, Collateral and Conditions. In our experience it is wise to reach a little wider and also have good disciples around assessing the Capacity & Conduct of trade credit clients. Let’s look more closely at these seven C’s of great credit management and some practical suggestions to make sure your credit is repaid:
| Some Practical Suggestions | |
| Character You will need to establish the character of the borrower. How trust worthy are they? What are they like as a person? Would they hold fast to their responsibility to repay the loan? |
Check your clients out. Google search, common friends on LinkedIn, ask for references (suppliers that are not friends of the debtor). Credit checks will inform previous defaults. |
| Capacity Who can be held responsible? Is this person seeking credit eligible to request it for their business? Can they be held responsible in the event of default or do they have an eligible guarantor if they are unable to meet their obligations? Remember: the legal basis of the credit is as important as the ability to repay. |
Do a company search or if an incorporated society – who are the office holders? What are the ages (18+?) of the client? If possible get guarantors from parents or parent entities. |
| Cash Flow Will the debtor have sufficient cash in the future to repay their debt. All debt is paid back in cash. If a company does not have sufficient cash flow for whatever reason, they will be unable to meet their obligations. |
If you are not an accountant or finance supplier your clients cash flow can be tough to assess as a trade supplier (eg Printer). If the credit is significant though get a copy of accounts and check liquidity ratios and other quick ratios. |
| Capital The amount of equity a company or individual has is important to understanding their capacity to take a ‘hit’ if their market undergoes hard times. If a business has sufficient working capital they will be able to continue to meet their obligations in a downturn. |
You are endeavouring to assess your clients financial resilience. Share capital is relevant for a corporate entity – other guidelines might be if they have survived tough times before. |
| Conditions This refers to how well the industry (of the debtor) is faring. It also looks at the economy relative to the business, and in understanding the relationship a lender can somewhat predict what direction the client is headed toward. When evaluating conditions there is also an emphasis on how competitive the market is. Will revenues fall because of a lot of competitors entering the market at lower prices? |
Use common sense – maybe google search for industry news. Be watching for obvious industry issues: eg You probably would not advance large amounts of credit to video store owners. Or in a recession a business selling expensive discretionary items. |
| Collateral What does the debtor have to secure the credit advance? What assets of importance do they have that they will pledge in case of default? Is this collateral liquid? Is it marketable and easily converted to cash? What percentage of the debt will the available collateral cover? |
If it all goes wrong what are your “side doors”. Eg – Can you recover your goods and resell? Has the business owner (are they wealthy?) given a personal guarantee? |
| Conduct It is important to monitor the debtor conduct once the credit is advanced. All good credit relationships must be managed properly and have their performance tracked, so that any red flags signalling a problem can be discovered early on and hopefully resolved. |
Does the debtors behaviour change once there is a credit relationship. Is it easy to get further information? Do they respond to your requests? Do they return calls? Are they pro-active if unable to pay on time? |
Using these checks and tips your business will find it will minimise the instances of trade credit default. There is however one final point to note which is extremely relevant in the current economy. The full Shakespeare quote I opened with is:
Neither a borrower nor a lender be,
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
The reference to “Husbandry” means domestic thrift or frugality. In contemporary times it is important to recognise that with record low interest rates, many business clients may have increased their debt levels and dulled their own sense of sensible “cost control”. It is best your business doesn’t have too many clients like this. Those clients may struggle to adapt to any increases in debt costs and to quote that other great bard: The times, they are a changin’.
Dave Birch
Managing Director
www.smartAR.com
Helping your business get paid … on time!