Although offering sales on credit might increase the volume of your sales, you will need to take into consideration that this model has a cost for your business. The value of the interest charged on an overdraft to fund the period of credit, or the interest lost on the cash not received and deposited in the bank. An increase in profit from extra sales resulting from offering credit sales could offset this cost.
Let us assume the following case:
- Company ABC runs wholesale business and for sales of its products for 10.000 EUR, enables them to earn a profit, after all other expenses except interest, of 200 EUR (i.e. a 2% profit margin);
- The current interest on overdraft is 6% per annum;
- Company ABC makes an arrangement to make a sale in amount of 10.000 EUR to company XYZ and the credit terms provided are 120 days after the delivery of the invoice;
In this case the profit, after all other expenses except interest, for the company ABC is 200 EUR and will only cover the cost for the overdraft needed to cover the credit period, which will be on the same level of 200 EUR for the above mentioned period of credit terms.
In other words, the entire profit margin, for the sales to the customer XYZ, has been wiped out in 4 months. Setting up the right level of credit terms is essential for your sales and profit.
On the other side if you do not know your customer very well you might find that the sales you have made on credit might end up as a bad debt. How many times you have been in a situation that you have sold to an unknown customer on credit and after constant reminders you realize that your customer had become insolvent and not able to pay your invoice? Or you have established relations with well-known company and after some time of cooperation you realized that they’ve gone bankrupted. If you’ve experienced such situation, you are aware that you have lost money and time. This type of cases doesn’t occur by accident. Most likely during your cooperation with the customer there were signals that were showing that something is not in order and you need to take some measures.
Implementing good credit control system will help your company minimize the risk of occurrence of bad debts and at the end of the day saves you money and time.
When setting your credit control system it is advisable to look after the following:
- Process of checking the creditworthiness of your customers;
- Set a minimum size order for credit accounts;
- Set a maximum credit limit for each customer;
- Calculate the administrative cost of debt collection;
- Minimize the risk of credit sales by using some of the products that your bank or insurance company is offering.
These are some of the factors that the management needs to take into consideration when setting up a credit control system. But in order to set up good credit control system and not to influence the normal operations of your company, you shouldn’t limit only to these factors as the process is complex. Need a professional advice in this area? We will be more than happy to help you.