At one level you should decide what level of bad debts are appropriate to your industry and build it into your cost of sales in the form of provisions. The level you decide will depend on the profit margins on each of the products you are selling.
If you are buying in goods at €20 and selling them for €22 – that doesn’t leave you with much margin for error, so you have to manage your credit very tightly and check out every customer and have a robust collection system in place to make sure every single account is paid exactly on the due date.
If you are buying a product for €20 and selling it for €100 – this gives you more margin to play with and you should adjust your credit policy accordingly.
In the first instance a bad debt level of 10% would wipe your margin out completely so your business would be unsustainable. In the second example, if you thought by applying a more liberal policy would result in additional sales, and additional bad debts, simply do the sums on how much extra sales would you get, and calculate the profit on that. Then calculate the projected bad debts and calculate the losses on that. As long as your profit exceeds your losses, you were better off making the decision and that is what we mean when we talk about managing credit for profit.
The role of every manager and employee of a business should be to make more real profits. As long as you are generating more for your company than you are costing your position is secure. As soon as you become a cost, and worse still if the cost of keeping you exceeds the value you are bringing in to the business then your days are numbered.
I see the role of Credit Management as the managers of the margin. We have to make sure all our sales are turned into profitable sales by turning them into cash – which after all is the true measure of success for a business.
Work with your finance people, work with your marketing people, they probable have models that will help you decide on a number of these factors and they probably don’t even know it. Ask them the question “What would happen if we moved to a high risk market in terms of additional sales and profits?” Then using your expertise in credit estimate the value of the increased bad debts as a result and calculate if it is worth doing this business or not.
There is a second factor you need to take into account which is the difference between the Fixed and Variable costs in your business, the higher your fixed costs the more profit you will make on each additional unit of sale.
If you are in business and tell me you have no bad debts, either you are really good at your job or you are taking too strict a line in credit and passing up some real opportunities that exist on the business you are turning away. Unless you can quantify this and show the senior managers the value you are adding through your intelligent action you will not receive the recognition you deserve. This simply comes down to reporting – what you report on and how you measure your success – we will be talking about this topic in future articles.