Know the Metrics
Having receivables and extending credit to customers feels a lot like acting as a “financier”, and requires some of the same credit-decisioning tools used in financing processes. Whenever you are taking credit risk on a customer, knowing how much risk your company can take on and measuring that risk becomes critical. This is where all your actions originate from, and give you a thoughtful, holistic AR policy.
Start by defining the ratios that
make your business tick
Your business is unique. So are your margins, sales process, and customer relationships. All of them make up your bottomline. That’s why defining how your financial ratios impact your business gives you the insight you need to design your credit policy.
Remember, if you aren’t measuring something, you won’t know how to improve it.
Find out the AR metrics that
Knowing your cash cycle and your days sales outstanding, understanding how long it takes you to get paid based on customer profiles gives you a strong foundation to start from. It also helps you to know what exposure levels you are comfortable with.
Define your red lines and stress zones
Once you know your metrics, compile a list of ranges you know you can operate without taking on any extra risk. Many business get caught up in the excitement of a new sale and overlook the credit aspects of the customer, only to find themselves in a difficult working capital situation later on. You can avoid this pain with a little planning at the start.
Set limits based on your experience
and on what your business can afford
As you continue your relationship with a customer, you are collecting many data points that can tell you a lot about your risk exposure on that customer. Incorporate those experiences into your calculations going forward. It’s your own data and even the credit bureaus might not know about it. It is valuable. Use it in your process to get better at extending credit.