There are three measurable elements in calculating the cost of credit:
- Interest paid or not received
- Depreciating Currency
- VAT Financing
Interest Paid (or not received)
Business cash flow is generally aided by an overdraft at their bank; this is a key element in the calculation the cost of credit given. If the business does not have an overdraft it will therefore be losing interest received if the money had been on deposit. (There is an additional factor that cannot be calculated, that factor is opportunity cost.)
For companies selling services the cost of overdraft facilities can be minimal, it becomes more serious when the company provides good on credit.
To calculate this cost at 10% on £100,000 owed by debtors:-
£100,000 X 10% then divide by 365 = £27.40 per day.
£27.40 does appear little to be concerned about, however it is £833.33 per month, and £10,000 per year – is that substantial enough?
Inflation is a cost to business in the same way as a bank overdraft. £100,000 is worth less and can buy less at the end of the year than at the start by the amount of the inflation rate.
Therefore the calculation is the same as above, 3% has been taken as the example inflation rate.
£100,000 X 3% then divide by 365 = £8.22 or £246.60 per month or £3,000 per year.
VAT is normally payable quarterly; therefore by the end of April each year, your company will have to pay VAT for Jan, Feb, and March. Again it is the same simple calculation based on the £100,000 having an additional VAT amount of £17,500.
£17,500 X 10% divide by 365 = £4.79 per day or £143.70 per month or £1748.35 per year.
Often the daily cost of debtors is not calculated until there is a problem with credit control. From the above example we can see that £100,000 of Debtor accounts is equal to £40.41 per day, or £1223.63 per month, or £14,748 per year.
It is the last figure that I find startling. I have experience working in many companies that had constant cash flow problems while at the same time refusing to fund credit control properly – often they believed that they could have an untrained someone just phoning their debtors.
The figure of £14,748 also illustrates how easy it is to pay credit controllers on incentives, and how some of the credit controllers measures are very helpful the health of the company.
I hope this helps you see credit control in a different light.