How to Control Debtors in Small Business


The question of investment in debtors is vitally important, as the survival of any business depends on its ability to generate cash. For ex­ample, when a sale is made on credit, a profit may well have been earned in accounting terms. However, the cash may not be received from the debtor for a considerable period. Thus, if debtors are not well controlled and are allowed to increase at a disproportionately faster rate than the growth rate in sales, it is possible that a cash shortage will occur despite evidence of profitable trading. How can this situation be avoided? The bank manager may be able to assist by increasing the company’s overdraft facility, but is this the right answer from the small businessman’s point of view? Further finance from the bank will result in an increase in the overheads of the business and it is possible that only a temporary solution has been found which does not resolve the underlying problem – poor debtor control.

Debt Settlement

How can improvements be effected in this area? It seems that certain basic questions have to be answered by the small busi­nessman prior to action being taken. What is the size of the investment in debtors? How is it financed? How can the invest­ment be reduced without harming the firm’s ability to meet its objectives? To aid the small businessman in this assessment and in taking suitable action we will outline the various aspects of debtor control that should be examined.

The significance of debtors

The businessman should be aware of the following factors:

1. What is the cost to the business of granting credit? The costs involved can include interest charges, administrative over­heads, legal costs, etc.

2. What are the true costs of granting discounts for early pay­ment to customers? It may be worth giving discounts if liquidity is a problem, but it should be remembered that a 2.5 per cent discount for payment within 30 days when the normal terms of trade are 60 days is equivalent to an annual charge of 30 per cent (2.5 X 365/30 = 30.4).

3. What return on sales do you achieve in your business? If, for example, a 3 per cent return is achieved, it is evident that a £3000 bad debt will nullify the profit on £100,000 of sales. On the other hand, if bad debts are not incurred, are busi­ness opportunities being missed?

4. How many days on average does it take to collect one day’s sales? This is a useful ratio and changes over a period will give an indication as to the effectiveness of the debt collec­tion system.

5. It is a fact that growth in credit sales volume will necessitate an increase in the working capital requirement. Has the amount being assessed?

Recognition of the implications of these questions is vital to the understanding of the significance of the investment. However, to complete the picture, it is equally important that the detailed procedure of day-to-day control of debtors is fully appreciated.

The management of debtors

It is obviously vital that the creditworthiness of all new customers is assessed. The sources of information which can be used in­clude banks, the trade generally, credit registers, etc. However, it is equally important to check periodically on the credit­worthiness of your existing customers. A change in their pay­ment pattern may well suggest that inquiries should be made. In this respect it is always useful to give accounts credit limits in order that any change in trading activity can be readily identified.

Debt

Assuming that the credit risk is acceptable and that limits have been established for all the customers, it is vital that a good collection system is in operation. The approach which should be adopted in this respect is fairly simple:

1. Send the invoice as soon as possible, and at the very latest at the time of despatch of the goods. Very few customers pay on invoice, and none pay before it!

2. Send the statements appertaining to the previous month’s invoices as soon as possible after the month end; at the latest by the third or the fourth of the month following. Statements are often not sent out until the middle of the following month and this generally results in an extension of the time taken to pay by the customer.

3. State clearly the terms of sale, settlement, etc on all state­ments and invoices as this can avoid ‘delaying tactics’ by your customers.

4. Ensure that at the end of the month a list of debtors out­standing is produced, aged on a monthly basis. This docu­ment will facilitate the identification of overdue debtors and enable appropriate action to be taken, ie telephone calls, letters (a series of three letters should be devised, by which each is progressively tougher). Do not be afraid to chase overdue debts. Many businessmen consider that to chase debts from important customers will result in a loss of future business. This fear is more imagined than real, and it is probably fair to say that the companies who ‘shout the loudest’ tend to be paid and respected for it.

5. Ensure that no further goods are despatched to those cus­tomers who appear on the ‘overdue list’.

6. Consider the possibility of obtaining credit insurance.

When a debt becomes doubtful it is important to ensure that any action taken is cost-effective. If, for example, the debt is £20, it may well be that the administrative and legal costs involved in recovery will be greater than the original debt. However, when larger sums are involved and it has been estab­lished that the debtor is worth pursuing, the employment of debt collectors or solicitors should be considered.

These procedures may appear to be time-consuming, but the implementation of such a system of debtor control may well be highly beneficial to the company in terms of reducing the level of investment in debtors and thereby improving liquidity and profitability.

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About the Author: Marie Mayle is a contributor to the MegaHowTo team, writer, and entrepreneur based in California USA. She holds a degree in Business Administration. She loves to write about business and finance issues and how to tackle them.

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