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Actionable Ways Companies Mitigate Credit Risk

Topics: Finance, Credit & Payments, Management

Offering customers credit has become the norm but so has writing off uncollected payments. Customers expect credit terms on invoices. For suppliers, every invoice issued on credit increases their credit risk.

In this article, we'll see methods you can start using to help mitigate credit risk associated with the extension of customer credit.

Early Discount Terms

Early discounts are not only an incentive for a customer to pay their invoice early, but they also reduce the probability of that customer not paying.

Sharespace found that companies who have implemented and are successfully managing early payment discount programs are saving ~$1M for every $1B in spend.

Which discount works best will require some trial and error. A 2/10 discount (2% discount if paid within ten days) for example might be a great place to start. From there, you can test 1/20 discounts (1% discount if paid within 20 days). You'll likely find that the higher discount terms tend to perform the best.

Besides improvements to credit risk, you'll see cash flow improvements as well.

Early discounts are part of your overall credit policy. Part of mitigating risk is knowing what isn't working vs. what is working. Track changes to your credit policy so you can better understand what is having an impact. It's best to try and not implement more than one change at a time. Otherwise, it will be difficult to understand what impact any change is having.

Automating Credit Risk Management Through Software

Trying to manage the accounts receivable lifecycle manually is obviously not sustainable unless you have minimal accounts receivable. Many companies are turning to software to help them automate much of the A/R process and in some cases the entire process.

Companies such as highradius and Anytime Collect offer integrations that can handle the following scenarios:

  • Sending of invoices
  • Payment collections
  • Sending invoice due notices
  • Handling collections

Specific to Highradius are the following offerings:

  • EIPP Cloud - Low-cost invoicing through web, email, fax, print + mail and secure payments with ACH, credit cards.
  • Cash Application Cloud - Zero-touch, straight-through remittance capture and payment posting.
  • Collections Cloud - Automated dunning, improved collector KPIs, lower past-due and DSO.

Anytime Collect is similar to Highradius in that it helps automated the A/R life cycle and helps reduce overall credit risk. Anytime Collect integrates with a large number of accounting products, including Quickbooks and sage to name a few.

Implementation of software platforms can take some time and will likely have to be done by the company selling the software. This can result in a high initial cost. Understanding if it will outweigh the losses you are incurring will help with the decision to implement or not.

Invoice Factoring For An Immediate Cash Flow Fix

Sometimes there simply isn't any time to integrate a more extensive system or develop a thorough plan when your A/R seems to be spinning out of control. In this scenario, a company is probably facing increased overdue invoices, increased non-collection of payment and a cash flow crunch as a result.

To get cash flowing back into the company and the A/R life cycle under control in a hurry, invoice factoring is the solution. Once you've chosen a factor and they have begun processing invoices, you can receive 70%-95% of the outstanding invoice amount as a cash advance. Once the factor has collected payment from customers, they will send you the balance, minus a factoring fee.

Factoring fees can be a small price to pay when your company is in a crisis and needs an immediate cash flow fix.

However, don't become dependent on invoice factoring. It is only a temporary fix. The deeper problem still persists. It's important to understand how you got into such a crisis in the first place and implement a permanent solution. Invoice factoring can buy you some time to figure out the issue while also fixing a cash flow shortage but it isn't a permanent solution.

Strengthening Your A/R Team

If you decide to automate much of your A/R life cycle through software, humans will still be needed to make credit risk mitigation a success. Automation can certainly do a lot, but it can't do everything. Having experienced people on your A/R team to oversee processes and ensure everything is optimally performing will help maintain a stable A/R system. A well humming A/R system will allow you to create accurate collections forecast, which in turn means better cash flow projections and scheduling of new projects.

Depending on how much automation your A/R system has, increasing the number of people on your team may be a necessity. Identify any blind spots within your current A/R system. If you aren't ready to automate those areas, they might need additional people maintaining them.

Part of strengthening your A/R Team also means documenting processes. People come and go. Allowing someone to build up tribal knowledge puts your A/R system at risk. A well documented A/R system is a risk mitigator. Such documentation is also a tremendous onboarding tool.

Credit Insurance As An Additional Risk Mitigation Tool

Credit insurance can help cover a large percentage of bad debts. Some insurance companies will cover up to 95% of bad debts. This helps ensure you have consistent cash flows, even if your customers don't. 

Credit insurance helps in reducing counterparty risk, specifically where a customer is unable to meet its obligation. 

Credit insurance also stabilizes your balance sheet. Rather than showing losses for bad debts, you'll instead be covered up to a relatively large percentage of those debts. This can be especially useful when you need financing from a lender. The insurance company can reassure the lender of coverage for any bad debts.

Many credit insurance companies offer online access to monitor credit issues. This provides you with analytical insights (via credit risk models the software is running) into how your credit policy is performing and an ability to see issues as they develop.

Like invoice factoring, shop around for the best insurance rates.

Risk Vs. Risk Mitigation - Which Should You Choose?

There are costs involved with using any of the risk mitigation techniques covered in this article - both in time and money. Initial costs are quite high due to implementation and training of staff. Thereafter, there is a fairly set cost over any period (i.e., monthly or quarterly).

In trying to answer this question, is risk mitigation better than taking the risk, knowing how DSO is trending, performance of payment collection vs bad debt, the impact of invoice discounts and other factors of your credit policy will be key.

Does your DSO compare to your industry's norm? The following are DSO averages by sector in the United States from a 2014 PwC working capital survey:

  • Food, drink & tobacco - 25
  • Construction - 39
  • Consumer goods - 38
  • Automotive - 54
  • Retail & wholesale - 14

The above stats and many others can be used as comparisons against your own credit policy key performance indicators.

The question for any company to answer is: Will the period cost of any risk mitigation be less than the cost of incurring losses without risk mitigation?

To help with this question, we have designed an AR calculator.

Net terms accounts receivable

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Apruve enables large enterprises to automate long-tail credit and A/R so you can stop spending 80% of your time and resources on 20% of your revenue. We partner with each of our customers to solve their unique credit, payment, and accounts receivable challenges and build the right credit solutions for your markets, customers, and goals. 

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