This is the final article in our three-part series on how to offer competitive payment terms without taking on risk. Learn how to create your own credit management program step-by-step. Also find out how to balance your risk versus your customer’s risk and look at the strengths and weaknesses of the most commonly used payment options.
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As experienced business people know, simply offering a high-quality product or service doesn’t guarantee a sale. Customers usually look at several factors in the package before making a final purchase decision, including fair price, timely delivery and, increasingly, flexible payment terms.
For the seller, this presents a trade-off. Offering flexible payment terms makes your company’s offer more competitive, helps you to increase sales, and presents a gesture of goodwill, the foundation of building strong relationships.
On the other side of the coin, it’s risky to extend credit to new customers – and this is even more so when your buyer is located in another market, making it harder to pursue and enforce collection if non-payment occurs.
Extending credit also means that you can’t eat your cake and have it, too. Allowing your customer to delay payment means you don’t have that money available to fulfill the order, to conduct research and development, or to find new customers and grow your business in other markets.
Some accept this compromise as simply the cost of doing business. But in fact, as many companies have figured out, having trade credit insurance can give you all the benefits of being able to offer flexible payment terms, as well as ensuring you’ll get paid and can eat your cake as well.
Trade credit insurance does double duty
Trade credit insurance (also known as export credit insurance) is a type of commercial insurance that protects your accounts receivable against losses when a customer doesn’t pay. This means you can offer your overseas customers highly competitive payment terms, such as open account, without risking major financial losses. And including flexible payment within your offer can spell the difference between making an important sale and losing it.
“This kind of insurance helps companies mitigate their risks when they need to provide flexible terms for their international clients,” says Sarah van Wolde, Senior Underwriter at Export Development Canada (EDC). “If the customer doesn’t pay, you’ll still receive most of your funds. As a result, using trade credit insurance can make you more competitive—it means you can offer better terms without increasing your risk to uncomfortable levels.”
“This kind of insurance helps companies mitigate their risks when they need to provide flexible terms for their international clients.”Sarah van Wolde,
Export Development Canada
Learn how you can gain a competitive edge by offering flexible payment terms to overseas buyers, while still keeping your financial risks under control.
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the key to offering flexible terms
When deciding on the right payment terms to offer your customer, start with their credit data. This is relatively easy to do in Canadian and U.S. markets. It’s harder to find information such as financial stability, credit standing and payment records of potential customers located overseas – unless you know where to look.
The Canadian Trade Commissioner Service (TCS) is an excellent source of information, since they can give you a good idea of the standard payment terms used by your industry in your target market. The TCS office in your market will also be familiar with local business conditions and may be able to advise you on the reputation of a prospective customer within that market.
Another resource is EDC, which offers a wide range of up-to-date business intelligence. You can access Country Profiles to asses risk in markets around the world, visit our Economic Insights for in-depth economic analysis and reports, or browse the events calendar for upcoming seminars, webinars and trade missions.
Your industry trade association may also have resources and information you can use, and there are numerous international credit agencies that will provide credit reports on a fee-per-company basis.
create a credit management program
You might know where, when and how you want to extend flexible payment terms, but do your employees know as well? Developing an effective, clearly communicated credit management program that can be applied consistently across your company is crucial to offering flexible terms without exceeding your risk threshold.
“With a good credit management program, you can set credit terms and policies that are shared throughout your company, so that your staff knows how they work and what the repercussions will be if they aren’t honoured,” says van Wolde. “This also allows you to communicate your terms clearly to your customers, so they are aware of what will happen if they don’t meet their payment commitments. Your credit management program also helps you to track how well your customers are doing. This can allow you to spot any changes in payment patterns that might signal a risk to your cash flow.”
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6 steps to create your own credit management program
An effective credit management program is a carefully developed policy, set out in a document, which governs how you offer international credit and handle overseas transactions. While the details of the credit management process vary from company to company, most programs are based on some variation of the following steps:
Collect basic information about the customer
You’ll need basic data about a prospective customer before you can decide how flexible your terms can be. Your standard credit application should ask the company for the following information:
- Corporate data, including the company’s legal and trade names (getting the exact legal name is vital), its head office address and the contact information for the person(s) responsible for purchasing and payment.
- Basic bank information, including the legal name of the company’s bank, the company’s account manager at the bank, its borrowing capacity with the bank and its current credit balance.
- The names and contact information of at least three businesses that have extended credit to the company, together with the credit limits provided by these businesses and the dates of the company’s most recent transactions with them.
Check the customer’s credit history and establish credit limits
Next, use the information from the credit application to dig farther into the company’s credit and payment record. Unearthing this kind of information about foreign companies can be difficult, especially in emerging markets. But making the effort can pay off in better protection for your cash flow. To do this, you should:
- Contact the suppliers listed on the company’s credit application. Ask each supplier to verify the company’s credit limits and its balances, and request a rundown of its payment record. Try to get the information in writing.
- Talk to the prospective customer’s bank to find out how long the company has been banking there and how closely it works with the bank. Ask the bank to verify the company’s credit capacity, how much of this capacity it regularly uses and what kinds of credit instruments it can access.
- If possible, obtain the company’s recent financial statements. Audited statements are more reliable than unaudited ones, and can provide a good view of the business’s liquidity, profitability and cash flow. If you can get an overall picture of the firm’s accounts payable turnover, this will suggest how quickly you’ll get paid. It will also help you assess the company’s long-term reliability.
- If it seems appropriate, have a credit agency provide you with comprehensive reports on a company’s past creditworthiness and its financial and payment history.
- Use the information to decide whether the customer will be an acceptable credit risk, and to establish the credit limits. A good rule of thumb, when deciding on a limit, is to keep to the lower end of the amounts extended by the other suppliers. You can always increase this if the customer proves to be reliable.
Build customer relationships
Your number-one tool for managing a customer’s credit risk is building a long-term, trusted relationship. You can start laying the groundwork by discussing your credit terms with the customer at the time of the first sale. This will help you gauge the customer’s attitudes to credit and ensure they clearly understand what you expect of them.
Establish clear credit and payment terms in your sales agreements
A sales agreement that includes a clear, comprehensive description of the terms of credit and payment will minimize the risk of disputes and improve your chances of getting paid in full and on time. Having all the conditions fully documented in the agreement is vital, especially if the customer fails to pay.
Regularly update your customers’ credit standing
A customer’s creditworthiness can change over time, so establish a monitoring routine and keep credit information up to date. In addition, you should review a customer’s credit file if:
- The company asks for an increase in its credit limit.
- The company asks for a major change to its usual payment terms.
- It has been more than a year since the company has made a purchase from you.
- The structure, management or ownership of the company changes.
- You spot red flags such as a change in payment habits over time.
Use a standard process for handling overdue accounts
Your chances of collecting on a delinquent account are highest in the first 90 days after the due date. Be sure you have an established routine for dealing with late accounts, so you can start the collection process as soon as you know there’s a problem.
The bottom line
Once you’ve created your credit management program, treat it as a living document. Build on it to assign staff responsibilities, fill in procedural details and set up the program’s processes. Review the program on a regular basis as your company grows into new markets and gains new customers.