Evaluate customers and suppliers
Excerpt reprinted with permission from The Credit Crunch: a Practical Guide, Grant Thornton LLP, 2008
What’s the issue?
The recent challenges in credit markets as well as a general economic downturn have put increased pressure on the purchasing power and credit-worthiness of customers while at the same time resulting in a tightening of credit terms and product availability from suppliers.
What can you do?
Re-evaluate credit terms with customers and negotiate the shortest reasonable terms. Carefully review (and continuously monitor) the credit-worthiness of each new and existing customer before extending credit to better ensure full repayment in accordance with stated terms. Monitor accounts receivable aging and quickly address any problem accounts that are past due. Request regular financial information from your largest customers to identify and evaluate risk. The buyers of your services may themselves not understand the financial position of their employer. Ask yourself a simple question: If your customer were to file for bankruptcy tomorrow, what would happen to your business? It’s prudent to understand the credit profile of any customer who could severely impact your business if it runs into trouble. As an unsecured creditor in a bankruptcy, you will probably not collect anything from your receivable, considering that the claims of certain government agencies, employees and secured creditors all rank ahead of you.
Understand how closely your business is linked to the average consumer. Your proximity to, or distance from, them will indicate how quickly your business will be affected as consumers exercise greater caution in their spending patterns. The most vulnerable sectors will be those that rely on discretionary consumer spending and credit, such as housing, automotive, retail and other consumer durables and non-durables. All of these businesses will be affected by customers’ tighter access to credit in the months ahead.
Take the opportunity to bargain for the most favourable credit terms with suppliers, which are as long as possible. To the extent excess cash is available, negotiate for early payment discounts as most suppliers will be hungry for cash. Critically evaluate whether you need more or fewer suppliers. Do you need to expand your supplier base because some of your suppliers are financially weak? Do you need to consolidate your suppliers, put more of your business with fewer providers and negotiate more favourable terms for your business? Either strategy could work, but only a robust analysis will provide the right answer for you.
What to avoid?
Don’t assume your customers or suppliers are financially healthy. Look for red flags of distress. Failing to promptly collect receivables may result in a cash flow shortfall that could affect all areas of your business. Accordingly, extending unreasonable credit terms in the hope of bolstering revenues may be equally detrimental. Immediately investigate any hiccups with your suppliers. Make sure delivery or quality mistakes are just that, and not an indicator of more systemic problems.