How to Keep Cash Flow Strong by Managing Customer Credit Risk

Imagine your business is buzzing, sales are growing, and orders are coming in strong. Yet, when you look at the cash flow, something’s off – money isn’t lining up with the sales you’re making. This disconnect often comes down to one critical issue: customer credit risk.

For CFOs, understanding and managing this risk isn’t just about avoiding losses; it’s about keeping your business financially stable, especially in times when cash flow can make or break your operations. Here’s a practical guide to understanding and managing customer credit risk effectively.

What is Customer Credit Risk?

Customer credit risk is the risk that a customer who buys from you on credit may not pay on time – or may not pay at all. When you extend credit, you’re allowing a customer to buy now and pay later. This can be great for sales, but there’s always a chance that some of those customers won’t pay as agreed. Managing this risk means making sure that you’re getting paid and not sacrificing cash flow to boost short-term sales.

Why Does Customer Credit Risk Matter?

In South Africa, many businesses, particularly SMEs, rely heavily on credit sales. Late payments or unpaid invoices can seriously impact cash flow, making it harder to cover essential expenses like paying employees, suppliers, or rent. Without steady cash flow, a business can quickly find itself in financial trouble. As CFO, your role in managing this risk is essential – it’s about protecting the lifeblood of the business and ensuring that the cash flow remains stable and reliable.

Practical Steps to Manage Customer Credit Risk

Here are five straightforward steps to reduce customer credit risks and keep your business financially healthy.

1. Know Your Customer

Before extending credit, it’s crucial to understand who you’re doing business with. Check their credit history and payment patterns, especially if they’re a new customer. Have they paid other suppliers on time? Are there any red flags in their financial background? Spending a little time upfront on background checks can prevent bigger issues down the line.

Use local credit bureaus like Experian or TransUnion, or request trade references to get an honest picture of the customer’s creditworthiness.

2. Set Clear Payment Terms

Clear, simple payment terms help manage expectations and prevent misunderstandings. Make sure your customer understands the due dates, penalties for late payments, and preferred payment methods. This clarity can reduce late payments, which keeps cash flowing and reduces the need for awkward payment chases.

Consider offering early payment discounts to encourage timely payments. Also, clearly outline the consequences for late payments, like interest fees or paused services.

3. Regularly Monitor Your Accounts Receivable

Keeping an eye on your accounts receivable is essential for catching potential problems early. By monitoring outstanding invoices regularly, you can spot changes in payment patterns. For instance, if a reliable customer starts paying late, it could be a warning sign of deeper issues.

Use accounting software to track outstanding invoices and automate payment reminders. This can save time and reduce the chances of payments slipping through the cracks.

4. Establish a Credit Policy

A clear credit policy makes it easier to decide who qualifies for credit, under what terms, and when to tighten or loosen these terms. It should outline how you assess a customer’s creditworthiness, set credit limits, and handle overdue payments. For example, customers with lower credit scores might have a stricter limit or shorter repayment terms.

Review and update your credit policy annually, particularly if market conditions change or if you notice shifts in customer payment behaviors.

5. Act Quickly on Overdue Payments

Don’t let overdue payments linger. The longer a bill goes unpaid, the less likely you are to collect it. When a customer misses a payment, send a reminder immediately. If payment is significantly overdue, it might be time to involve a collections agency or reconsider that customer’s credit terms.

Set automated reminders for overdue invoices, and if there’s no response after two reminders, make a personal call to the customer. If payment is still delayed, consider involving a third party or halting future credit extensions to that customer.

Red Flags to Watch For

Early detection of credit issues can save you a lot of trouble. Here are some common warning signs of credit risk:

Consistently late payments: If a customer is frequently late, they may be struggling with cash flow themselves.

Requests for higher credit limits: If they ask for an increase without a clear reason, proceed with caution.

Inconsistent order patterns: Large orders followed by long payment delays can signal cash flow issues on the customer’s end.

Stay vigilant and address these issues as soon as they arise to minimise your risk exposure.

When to Tighten Credit Terms

Sometimes, tightening credit terms is the best way to protect your business. Here are situations where stricter terms might be necessary:

An economic downturn that raises risk across the board

High exposure to a few large customers, where a single non-payment could impact your cash flow significantly

A trend of overdue accounts that’s affecting cash flow

Keeping credit terms flexible and aligned with market conditions helps protect your business from excessive exposure.

Balancing Sales Growth with Cash Flow Stability

Managing customer credit risk is about striking a balance between growing sales and maintaining healthy cash flow. Offering credit is often necessary, but it should never put the financial health of your business at risk. By following these practical steps – getting to know your customer, setting clear terms, monitoring accounts, establishing a credit policy, and acting quickly on overdue payments – you can minimise your exposure to credit risks.

Ultimately, good credit management doesn’t just protect your cash flow; it builds trust with customers. They see you as a business with clear, fair practices, making them more likely to pay on time. And with a reliable cash flow, your business remains resilient, ready to face whatever challenges come its way.

Managing customer credit risk is an ongoing process. Involve your finance team, use technology, and don’t hesitate to get professional advice if needed. A proactive approach to credit risk keeps your business healthy, your relationships strong, and your cash flow predictable.