“Business to Business credit is seen by many as one of the riskiest assets a company can hold, with numerous firms severely affected by late payments and bad debts.” According to Frank Knight, CEO of Debtsource, the consequences of slow or non payment include erosion of profitability from sales, and in some cases where margins are tight, profit may be eliminated altogether. “In instances where B2B credit is granted without careful consideration, the viability of the firm may be threatened, especially where cash flows are not strong enough to support losses or late payments.”
In South Africa over 80% of B2B transactions take place on credit and this form of finance has become a very powerful capital instrument, which fills the gaps not catered for by the traditional capital markets. In other words, where a smaller business is unable to receive funding from bankers or investors it is not uncommon that the business will seek to make purchases on credit from suppliers, which also creates the opportunity for the business to extend credit to its customers and thus making the business more competitive and potentially more profitable.
The key however is to grant credit effectively and profitably according to Knight. “Granting credit for maximum opportunity and minimum risk depends on the application of successful credit management techniques that starts with good planning and ends with constant review.” Credit management is a value chain – if any element of the credit extension process is defective, the entire process could (and usually does) collapse. The elements of the credit value chain all depend on each other – pointless for example to employ a brilliant debt collector to manage non-paying debtors, but then not to spend the time and effort to research the debtor before opening their account.
The other risk factor that companies must consider when deciding their credit process, is that unlike consumer debt, commercial debt requires far quicker intervention. Smaller businesses especially can close down very quickly with little prior warning, and as soon as the owners abandon their business there is very little hope of a successful recovery of the full outstanding amount. The average commercial debt is also typically much larger and thus it only takes a few non-performing debtors to affect the cash flow or profitability of the supplier. “While there are options to reduce this risk through credit insurance, credit bureaus, and possibly even debt collection, business owners must be wary that these are again only elements of the process, and not a solution within itself.”
Knight recommends that businesses take careful steps to plan the process – from the initial acquisition of the debtor through to eventual payment, and to consider what interventions are available for each step between. “It’s about defining the best possible process for your business and then having the discipline to stick to it.”