Managing Debt

Just as a car needs petrol, a business needs cash to keep going. But what happens when small and medium businesses run out of cash? How do they run out of cash in the first place? Tony Markwell examines ways to manage debt collection and credit policies effectively.

Managing debt collection is a process many SMEs neglect, often at their own peril. Competing business pressures and the desire to increase operational volume and deliver mean many small and medium businesses don’t devote a lot of time to the debt collection process. In some businesses the debtor book is one of the most significant business assets.

An active debt management and collection policy is one of the most vital keys to managing cash flow and liquidity.

All businesses have a need at one time or another to offer credit to their customers but, unfortunately, this isn’t always possible. And when you can’t pay your bills on time, what becomes of your business? Do suppliers stop providing key raw materials? Does production falter? Clients often ask how their profit and loss statements look so healthy when they can’t seem to pay their bills. The answer lies in managing working capital levels and ensuring you have sufficient liquidity at your fingertips at times when you’re going to need it most.

In the accounting life of an SME, there is typically a cycle of purchasing products, manufacturing these products and provision of services, followed by, of course, the ultimate billing to the customer or client and then finally the collection of cash.

The time between the purchasing of goods or payment of wages to the employee, and the eventual payment by the client or customer, means that the business will have a working capital need which can be quite easily quantified in dollars for most businesses. How efficient the business is in minimising the time cycle between these stages will determine how much working capital is required by that particular business. Ultimately, this determines how successful that business is in terms of efficiency of capital invested by the equity owners.

Where there is a significant investment of the owner’s own capital in the business, particularly in SMEs, maintenance of an efficient working capital level will often determine the timing of payments to the owners (as they very often pay themselves last).

I recently witnessed a good example of the importance of managing cash flow where two businesses the same size and in identical industries were compared. It became apparent that the different debt collection and working capital processes dictated that one business needed an extra $3 million in working capital than the other to operate. This increase in working capital derived no extra return for the owners and in effect cost the owners significantly.

Policy Guidelines

So, what can SMEs do to manage their cash flow and speed up payment times? Start with the basics, such as a good credit policy. Business owners need to have a good credit policy covering all parts of the credit cycle. This could include: