MANAGING CREDIT RISK IN SMEs.

Running an SME involves a lot of decision making. One decision making scenario which often brings about dilemma is Customer Payment. It is crucial to always make the right decision, when it comes to customer payment because this can make or mare your business.

• Do I insist on outright payment immediately or do I agree that my customer pay later?
• How can I know that this customer would pay me at due date?
• What impact would not allowing credit, have on my business?
• How best do I make sure my customer pays?

These are the dilemmas when it comes to decision making as regards customer payments.

Giving credit to customers, in addition to being inevitable in business, is good practice. However, this, amongst other things is subject to what is called credit risk. As SMEs with little or no external funding, a late paying customer can create havoc. Maintaining a good credit system is the solution to managing stringent credit control and client relationship. It enables you to maintain your market share as well.

What is credit risk?

Credit risk is the uncertainty that a borrower or a business partner may default on payment or be unable to meet contractual obligations. Whether it’s a total or partial loss, it can lead to a disruption of cash flow, increased cost of revenue collection or the ultimate downfall of your business.

Unfortunately, it is impossible to know exactly what customer, business partner or vendor will default on obligations. To effectively manage this risk, it is vital that you set up a system to which controls customer credit. With a good credit management system, you monitor customer credit, aging defaults (how long a has customer defaulted), keep track records that can inform both subsequent transaction with that customer and what level your business operations become vulnerable to loss. This reduces the impact of defaults or keep loss at a minimum especially during peak periods.

“All businesses must have a good credit management strategy”

How can I reduce my business credit risk exposure?

Some SMEs may choose to have a credit control department designated to assess this risk and come up with strategies to reduce its impact on the business. However, you can introduce the following to your credit management process to reduce default on payment.

1. A credit control application form. Is the customer requesting credit, likely to pay? Ensure that your customer fills a credit control application form. This gives the customer an idea of how serious you are with your business. The form should include (but not limited to) – company basic details like name, addresses, owners’ information, legal status, references from other business partners and so on.  After this, ensure to use this information to research on your customer’s credit history e.g. follow up on the reference provided.
2. Set a credit limit. This means that you should set a minimum and/or maximum credit limit to offer the customer based on your findings in (1) above. It should be a part of your credit policy.
3. Set out clear unambiguous terms of credit at the outset. Terms of credit includes payment terms (incase interests are included), maximum credit period (say 30days), actions you may take where the customer defaults. These terms should be stated in writing, no matter how informal the transactions seems. It would reduce a whole lot of strain on the relationship, if it gets to a point in which you have to forcefully recover.
4. Reward timely payment (Optional). An extra incentive for payment could be to offer a discount for prompt payment. This could facilitate payment from your customers and enable you collect. E.g. 10% discount if your debt is paid within 7days.
5. Send invoices promptly. You do not want to give your customer an excuse to delay on payment and tie up your funds. Deliver on your obligation and obtain proof of acknowledgement from your customer.
6. Continuous credit control. Do not assume your customer always have you in mind. Set aside a regular interval of the day to follow up on outstanding invoices. Do not put off those awkward conversations. This could be daily or weekly depending on how much credit your business can handle and payment terms you have set out.
7. Assess your credit monthly. Check total outstanding credit across your whole business in terms of sales or revenue. Compare outstanding payments to the total volume of sales you have done in a month. Comparative analysis gives you an idea of how much hazard your business is facing and if you are making progress.
8. Enforce a collection system. This should be a last measure. I know we have to manage relationships, therefore it should depend on the amount involved. You could engage a debt collection agency to assist in collecting long overdue credit from customers. Although, also ensure that your customer is aware of this at the outset.

Credit risks are calculated based on the borrower's overall ability to repay. Technology has afforded businesses, the ability to quickly analyze data. We can use this analysis to assess our risk profile or build a customer’s risk profile, This enables us make a decision on how much credit we can afford to give.