Why is this important?

For most businesses, cash flow is the very lifeblood of their organisation. Therefore, managing debtors is critical to small business. Without efficient credit controls in place the management of debtors can distract the business away from its core activities and divert its attention.

In fact, it may surprise you to learn that the majority of businesses that go broke in Australia are profitable. Yes, they were making a profit! So why did they fail? Not enough cash!

This highlights how important cash management is to a business. And one of the cornerstones for cash management is establishing credit controls. That’s what this document is all about.

What to do

What is a credit policy?

A Credit Policy is basically the ‘rules of engagement’ of how your business will grant and maintain credit with its customers. While some businesses have good policies and procedures, many others have poor policies which are informal and often inconsistent.

The main reason for this is that they are often not written down, or if they are, they are out of date, irrelevant, and in need of updating for the current economic climate.

Put a policy in place for credit control

The first step in establishing credit control is your credit policy. The fundamental questions your policy needs to address are:

Who does the business wish to grant credit to?

On what terms? 

Once these questions are answered, they establish the foundation upon which you can build your credit control system. However, you will soon discover that the key elements in controlling credit are consistency and discipline. There is no magic involved. It simply requires consistent effort and a disciplined approach to managing the process.

The following checklist is designed to assist you with the development of your credit policy.
Key Steps

• Determine the key elements of your policy
• Identify the Terms and Conditions you wish to apply
• Write your policy down in a formal document
• Ensure it is easy to comprehend and practical
• It should not be over restrictive yet at the same time it should set clear guidelines on the terms the business finds acceptable
• It should outline the process for granting credit, increasing credit limits, and debt collection procedures
• It should make clear who the business wishes to grant credit to and on what terms
• It should include a standard Credit Application Forms for customers and checklists for staff
• This will help staff follow the correct process for credit approval
• Educate and train staff on how the policy is to be applied
• Ensure your Credit Application Form includes your terms and conditions clearly stated, or attached
• It works best if you can arrange for this to be executed by the customer

Your credit policy should be constantly evolving and being updated. It is a critically important document and needs to be regularly reviewed.

Once your policy has been developed, it is important to ensure that it is properly and consistently implemented in your business:

• Staff training and education will assist with this
• Allocate responsibility for its implementation to a key staff member, who is not likely to bend the rules for ‘special circumstances’.

Understand the entity your customer operates through

It is important to understand the business structure your customer is operating through as your risk and exposure differs accordingly:

Sole Trader

• The sole trader is personally liable for debts they incur
• The business cannot be separated from themselves personally
• Each partner in a partnership is jointly and severally liable for the debts of the partnership
• This means all partners are equally liable for the full amount of the debt incurred, even if they have differing shares of the partnership
• The partners are also personally liable for the debts they incur
• The company is a separate legal entity and is considered separate from the directors and shareholders
• That means if the company incurs the debt, it is the company which is liable to pay for the debt, not the directors or shareholders
• Essentially this means that the directors and shareholders are not generally liable for the debts of the company
• This means that if a company owes you money, and it goes into liquidation, it is unlikely you will have right of recourse against the directors or shareholders
• It is only in certain circumstances that the directors of the company can be personally liable for the debts of the company
• Trusts can be particularly difficult entities to deal with because it is the trustee of the trust who is actually the legal owner of assets of the trust
• Although used throughout the commercial world, they are not as popular as companies
• Business owners operating through a trust structure are unlikely to be personally liable for the debts of the business, in a similar way to companies

Partnerships

Companies

Trusts

As you can see, the structures people operate through provide them with different levels of protection, and provide you with different levels of risk.

The question for you to consider when providing credit to your customer, is how likely are you to recover your money if the customer is broke or refuses to pay? This should form your customer credit assessment.
Granting Credit

Setting up effective credit control structures and administration is the first step in resolving debt collection issues. Other key items include:

• A signed credit application which includes acceptance of your Terms and Conditions is a vital document, as it acknowledges they accept these arrangements
• It also provides you with additional information for you to consider in regard to granting them credit terms
• It assists in the debt collection process, with clear documentation for debt collectors or solicitors to follow
• While you can check the credit references the most effective source of information is credit bureaus
• This information is subject to privacy limitations and so client agreement will need to be obtained
• Such checks can identify any new customers that have had bad credit experiences in the past, so they can at least be monitored
• Check if the assets of the business or owners are already secured
• Seek to gain a right over the assets or take a charge over the assets in the event of default
• This will secure the assets to you and you will need to be paid before the assets can be sold at a later date
• If the new customer cannot provide a satisfactory credit record ensure they should be required to provide a guarantor who is financially sound

It is important that the business owners and management adhere to the policy and don’t give special treatment, or grant favours to friends or long standing clients.  This undermines the system and sends the message to clients and staff that the business is not really serious about enforcement of the policy.

Credit Management System

It is one thing to put tight credit controls on new clients and customers, but don’t forget your existing clients.  Ensure they are abiding by your credit control terms as well as new customers

• Ensure your business has adequate systems to highlight debtors that are overdue or have exceeded their limit
• Make sure your credit management system allows you to determine your slow paying clients and their credit worthiness
• Information should include:
  • dated records of all transactions,
  • customers’ reasons for late payment,
  • when to expect payment

The key to credit control is to follow up debts early and consistently. Don’t put this task off, otherwise it will get out of hand.

Terms of trade

Correctly worded Terms of Trade establish a clear legal relationship with your customer from the beginning so there are no grounds for disputes.  This results in fewer bad debts.  This then improves cash flow and reduces the cost of managing unpaid accounts.

• If your competitor has a correctly worded Terms of trade, and you don’t, then you are at a distinct disadvantage.  You could be working for nothing while you competitors are paid on time!

Your terms should clearly state how the law will apply to goods and services which your business supplies. They should cover common areas of dispute including your liability for losses, alteration or cancellation of orders, deliver, risk and ownership of goods.

• For Terms of Trade to be enforceable, they must be disclosed prior to any commercial transaction taking place
• They can be displayed on your business website, displayed at point of sale, included in marketing proposals and quotations, with credit application and process.
• This is the single most common reason debtors give for not paying their account by claiming the goods or services provided were ‘defective’. This clause determines a time limit for reporting defects on goods or services you have sold.
• Once the time limit has expired, your client cannot use ‘defective goods’ as an excuse for not paying their account.
• This clause determines that the transfer of title of ownership of the goods only takes place once you have been paid for the goods, even if they have passed into your client’s possession. This allows you to repossess goods if you have not been paid as the goods are still legally yours.
• Also, if the client goes into liquidation, you can have the goods removed from the pool of liquidated assets, as they will not belong to the liquidated estate.
• If your client doesn’t pay this clause ensures they are liable for all collection costs.  It will also allow you to seek solicitor’s costs, or place their company into liquidation. It will also allow you to cease any further delivery of goods or services without penalty.
• It also allows you to charge interest on overdue accounts.
• If you grant customers greater than 7 days to pay their account this clause gives you the ability to have them listed as a defaulter if they fail to settle their account. This will adversely affect their credit rating for 5 years. This clause will also allow you to obtain on line credit reports on the credit history and credit worthiness of your new and existing commercial customers.
• The “Act of God” exclusion clause. This restricts your liability for events beyond your control, including Acts of God, war, terrorism, lock-out, industrial action, fire, flood, drought, storm, etc.
• This clause provides that any debt incurred is joint and several. This means that in the case of a partnership or joint account, all parties are equally liable for the full amount of the debt incurred.
• This clause provides that your client accepts the Terms and Conditions as presented. Also, that by ordering goods and services once they are aware of the Terms and Conditions they are deemed to have accepted them.
• If the goods cannot be recovered, and if your client real property, by agreeing to this clause you can take a charge over their property or assets.  All costs associated with this are borne by the debtor and the charge can only be withdrawn once full payment has been made.
• This clause essentially makes you a secured creditor in the event the customer goes into liquidation.
• This clause provides that if the goods are damaged or stolen after delivery then the insurance responsibility lies with your client, even though ownership may not have passed.
• This clause sets out your Return Policy. You can choose not to accept returns under any circumstances, or if you do, this clause sets the time limit for the goods to be returned.

5 Clauses to consider for your Terms and Conditions

Defects

Transfer of Title

Default and consequence of default

Privacy Act 1988

Force Majeure

Acceptance

Security and Charge

Risk

Return of Goods

Where to go for help

Do It Yourself

Australian Competition and Consumer Commission (ACCC)

The ACCC promotes competition and fair trade in the market place to benefit consumers, business and the community. It also regulates national infrastructure industries. Its primary responsibility is to ensure that individuals and businesses comply with the Commonwealth's competition, fair trading and consumer protection laws.

Australian Securities and Investment Commission (ASIC).

ASIC is Australia’s corporate, markets and financial services regulator and contributes to Australia’s economic reputation and wellbeing by ensuring that Australia’s financial markets are fair and transparent, supported by confident and informed investors and consumers.

Debt collection: your rights and responsibilities

This brochure is available through the ACCC and assists people who are currently dealing with debt problems, or being contacted by debt collectors. It outlines consumers’ rights under the Commonwealth consumer protection laws, as well as general advice for those who are having difficulties with their level of debt. The brochure also assists friends, relatives and advisers of these consumers. A number of agencies and resources are listed in the brochure that people can contact to obtain further information, to seek assistance or to lodge a complaint relating to debt collection practices.

Online Business Directory

NSW Business Chamber Online Business Directory connects you to thousands of businesses across NSW. With exclusive access to special offers and great deals, you will find a service provider, business partner or supplier who can meet your needs. Listing on the Online Business Directory  is open exclusively to NSW Business Chamber members.

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