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  • Credit granting policies to improve cash flow

  • In a recent article on Cash Management by the authors, we mentioned the importance of credit granting policies in the cash management cycle. This article elaborates on the importance of this and some of the issues that should be addressed in managing the sales processes, to facilitate the cash management that will follow.

    Management of Accounts Receivable is significantly influenced by a company’s sales procedures and credit policies and it is only through dialogue between the finance and the sales functions that these policies can be developed and implemented.  There is often tension between the two functions because finance has a desire to have airtight procedures with very high approval standards, to be absolutely certain that all sales are collected on a timely basis.  Sales has a need to have as few obstacles as possible to achieve a successful transaction. The first step is to ensure that all sales staff are well informed about the credit granting policies and procedures.

    The ultimate objective of these policies is to avoid bad debts and it is imperative that sales staff and their managers recognize the “cost” of bad debts. In a business with a 30% gross margin, a bad debt of $1,000 would require additional sales of $3,333 to replace the cost of the bad debt. This message must be driven home!

    Where the sales staff have the discretion to recommend or approve discounts, lower prices or extend payment terms, it is critical that they understand the “cost” of lowering prices. In a business with a 30% gross margin, a 10% price reduction will require a 50% increase in sales volumes at the discounted price to earn the same gross margin. Very few sales managers and their sales staff fully appreciate this fact and lose profit when they secure sales by giving a discount.

    Sales staff must be well-versed in payment terms and comfortable including these parameters in a discussion and agreement with new customers. It follows that variable compensation of sales staff should be based on cash collected or gross margin collected and not on the sales amount.

    Many businesses have pricing matrices that are determined by a variety of factors. One such factor may often be the terms of payment agreed, and with an existing customer, adhered to by the customer.  Consider allocating a customer to a different pricing category if they are a slow payer. This is often easier than engaging in potential arguments about discounts and interest on overdue accounts.

    Credit policies and terms are critical for determining a company’s credit exposure as well a customer’s   risk profile. Establish a procedure to set and approve credit limits – your gut is a bad prescription!  Too often we see clients who do not have clearly defined terms and limits, or operate their businesses without this strategy in place. Ensure that you specify for your staff:

    • What are the standard terms of payment and what justifies an exception;
    • At what dollar levels are credit decisions required to be escalated to more senior personnel;
    • At what level is a credit report from an outside agency required
    • The type of credit reports required;
    • How often is an updated credit report required;
    • Under what circumstances are existing credit levels reviewed;
    • Under what circumstances are financial statements of the potential (or existing) customer required;
    • Under what circumstances are guarantees by third parties required and what are the policies for obtaining those.

    Use a credit application form to obtain permission to gather information from third parties such as credit rating agencies, banks and other suppliers.

    Review all credit limits at least annually and larger limits more frequently. Consider the circumstances under which an updated credit agency report will be obtained. This is especially critical for customers that have a pattern of paying beyond the existing terms.  For larger accounts it may be a great opportunity to initiate a conversation with the customer, even providing an opportunity to ensure that they are aware that you are making an exception for them.

    How soon after shipment are sales invoiced and mailed? Delays in invoicing mean delays in receiving cash. A number of companies pay based on when they receive the invoice rather than the invoice date. How are the invoices delivered? Electronically, fax or mail? As part of the sales process, determine how best to expedite approval of your submitted invoice e.g. address it to the attention of the person approving it, rather than waiting for the customer’s internal distribution to figure out whose approval is required.  Also ensure that you know if the customer requires multiple copies and/or additional documentation to facilitate approval.

    You should also decide on the procedures to take and approval levels required if a customer wants to make purchases in excess of their credit limit.

    The best time to address how payment is to be remitted by the customer, if applicable, is when the credit limits and terms are agreed. Exceptions can always be agreed but it is helpful to agree on the method up front. The implications of each option can be quite different:

    • Cheque – by mail, courier, pick-up;
    • Credit card – authorization over the telephone, in person, by fax, pre-authorized;
    • Pre-authorized payment – charged to a bank account or a credit card;
    • Cash – always an interesting option;
    • Electronic Funds Transfer (EFT);
    • Wire transfers;
    • Payment service e.g. Telpay www.telpay.ca/
    • Interac online – (the same concept as payment of utilities online);
    • Email – all Canadian banks have a facility on their web site to pay by email using Interac e-Transfer (generally for amounts up to $3,000).

    In the next article in this series on Cash Management, we will discuss how to maximize your cash flow by focusing on the collection process.

    David Balmer is a Chartered Accountant with over twenty years of Treasury experience with companies such as RJR Nabisco, Cott Corporation and Maple Leaf Foods Inc. He has presented at treasury conferences in Canada and the United States. He has also earned treasury designations from treasury organizations in both the United States and United Kingdom. Contact David at dbalmer@sympatico.ca

    James Phillipson is a Chartered Accountant and a Principal of Mastermind Solutions Inc. www.MastermindSolutions.ca , with over twenty years experience in large and small businesses.  He has provided financial counselling to his clients since 1996, often in the role of or as a coach to a Controller or Chief Financial Officer.  James has experience in financial roles in a wide variety of businesses and industries.  Contact James at James@MastermindSolutions.ca