Debtors and Creditors

Debtor & Creditor

tick_mark20   Registered BAS Agents – Registration No. 80294000

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Debtors and Creditors are a serious management issue for all business and need to be taken seriously and managed carefully.

Debtors – Accounts Receivables

Providing customers with credit accounts are for many, a part of doing business and a way of enhancing the revenue capability of the business.  Offering credit terms can also give a competitive advantage to the business, particularly if a competitor does not offer credit terms.   It is a way of separating the pain of paying for a purchase, from the pleasure of that purchase.  A business has to be careful though about the overall extent of credit because business survival is

A business needs to be careful about the overall credit extended to debtors because survival is dependent on predictable cash flow.   A misconception many business owners have fallen victim to is the belief that if the business is profitable, then all will be fine.  This idea though is seriously flawed in that if all of the businesses cash is tied up in the provision of credit, a serious cash flow problem will exist that can drive the business into liquidation.   While offering and extending credit can provide positive outcomes for the business, there is, of course, inherent risks associated with giving credit to customers.

Risk Factors

Providing credit terms to customers can create cash flow problems when you are waiting for debtors to pay their account.  This, in turn, can reduce your ability to pay suppliers bills on time.  Because insolvency is measured by the ability of the business to pay its debts as and when they fall due, and a director becomes personally liable if trading continues past this point, it is certainly a risk consideration  the business must factor into any decision to extend credit.

Due to the fact that there is a time lapse between purchase and payment, reduced profit margins can result as a side effect due to the cost associated with the time value of money, or the need to borrow to sustain credit being extended to debtors.

Bad Debts also pose a significant risk to the business and particularly so when large sums of money are involved in sales made to a single or multiple debtors.  The national averages for bad debts as a percentage of sales are;

  • LOW – .065%
  • IDEAL – .2%
  • GOOD – .3%
  • HIGH – .5%
  • DANGER – 1%

Every business must make a profit or face extinction and bad debts do have a negative impact on net profit.  The way to prevent write-off is to manage the associated risks to eliminate as many risk factors as possible when making decisions to extend credit, and also in the collection process.  We can, therefore, now consider ways to control the risks associated with extending credit.

Controlling the risk factors

Credit Applications should be a standard part of the business decision process when requests are received from customers for the issue of credit terms to them.  While we recommend that a business has a customised credit application created by their Solicitor, ABBS can provide a standard credit application form to our clients to use in this process if needed.

Once a credit application has been received, careful credit checks need to be carried out to determine the level of risk associated with extending credit to that particular individual.

Once credit accounts have been extended to a client, careful monitoring of compliance with the agreed credit terms needs to occur with overdue accounts being followed up quickly and any extended non-compliance referred to collection agents.  The graph below shows that the risk of non-payment increases rapidly as the debt ages which makes it clear as to why this must be managed effectively.

Debtors non-payment risk chart

Cost Factors

What this means in real terms is that to recover from the lost revenue on a sale that resulted in a bad debt average of 1% could mean that the next seven sales or more would only provide a break-even outcome to cover that bad debt, dependent on the margins on which the business works.  This increases as collection costs escalate.

To follow up on monies owed to a business costs the business both staff time and other outlay costs.  Any additional costs must come off the bottom line of the business.

Finally, there are the debt recovery services costs which will be incurred when a debt is placed into the hands of a debt collector, solicitor  or court action commenced.

Creditors – Accounts Payable

In the same way, creditor accounts need to be paid promptly in order to maintain a good working relationship with suppliers.  A well-managed credit policy will ensure that this can happen on time.

Contact Us Today

If you would like to talk to us about debtors / accounts receivable management services we offer and how these could benefit your, contact us today for an obligation free consultation.

Should you wish to know more about ABBS, answers to questions we have been asked can be found on our Frequently Asked Questions page.  If you have a question that has not been answered there, please send it to us and we will add it to the list for the benefit of others.

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