Other Elements of Credit Cost
There are other elements of cost in credit control, though they are more difficult to quantify, however they should not be overlooked.
Before moving onto that I would like to deal with the implication these have on the cost to company profit. If net profit before tax is 3% and the problems with debtors is costing 2% of turnover, if that 2% can be reduced to 1% or even to 1 ½ % that makes a huge jump in the profitability of the company. Each company should be doing this type of analyses for all debtor and credit control related issues.
- Administrative Costs
- Bad Debt Risk
- Business Failure
- Administrative Costs
Sending out statements, telephone calls, sales ledge administration, yearly debtors questions from your auditors, and the time cost of management to oversee – these are all administration cost that cannot be ignored and should not be under estimated.
Bad Debt Risk
The older a debt is the risky it is. General rules for the reserve for bad debt provision typically follows a pattern like the following:-
- 0 – 30 days zero reserve
- 30 – 60 days 1% reserve
- 60 – 90 days 2% reserve
- 120 – 180 days 10% reserve
- Over 180 50% reserve
These are generally understood industry standards, however ask your auditor for the standards within your own industry. This clearly illustrates the historic correlation between outstanding debts, time, and the chance of being paid. All auditors know that bad debts increase with the age of the invoice, the interesting fact is the startling difference once an invoice is over 90 days, this shows that on a ledger that is untidy the area to concentrate on is the 60 – 90 days and never let anything go past 90 days.
This is the saddest of all the problems associated with credit control and debt management. Businesses do close while making a profit. Liquidity problems are common reasons in business failure. Not having the cash on hand to pay their own invoices or staff salaries while financing other companies through the debtor ledger is due to poor credit control policies or enforcement, or the business being undercapitalized.
This was touched on briefly in the previous section. Take the £100,000 of debtors which was used in the examples.
Could your business use a £100,000 capital inject right now? Are you sacrificing ideas and opportunities because of a lack of capital? Perhaps £100,000 is not realistic, what about £50,000 or think of it as half of what your current debtors ledger is.
Lack of cash, slow cash flow, and capital tied up in debtors can erode many expansion opportunities. This is why factoring has become so attractive, though that brings its own problems.