5th February 2024

Avoiding Risk and Improving Cash Flow

Credit risk. Sounds like quite a daunting term doesn’t it.

But it doesn’t need to be. Being exposed to a certain degree of credit risk is part of doing business in the modern day. Businesses need to find the balance between amplifying sales by granting credit and leaving themselves too vulnerable by granting too much credit, dealing with risky payers or offering credit terms that don’t favour themselves.

If you’re worried about credit risk, looking for ways to improve your cash flow or even grant credit to your customers then this article is for you. Here we discuss ways you can avoid credit risk and in turn, improve your cash flow meaning you’ll have a more financially stable business. And who wouldn’t want that?!

What is credit risk?

The risk of your customer defaulting on payments or paying you late for goods or services received can be defined as credit risk.

Most businesses allow their business customers to buy goods or services on credit which means they usually sign a contract promising to pay the full amount at a later date. If your customer fails to pay the agreed amount on time they’ll default on their payment, then you’re at risk of losing the money you’re owed and in some cases the interest that is added on.

All businesses that offer credit for their goods or services are exposed to some level of credit risk. How much risk you’re exposed to is dependent on the value of the credit you offer, the timescale given of paying it back and the customer that you’re granting credit to.

Your customer’s behaviour is the biggest factor in the amount of credit risk you’ll be exposed to. It’s vital that you have a clear gauge on how likely your customer is to pay the agreed amount on time, whether it’s in full or agreed instalments. The best way to predict this to look at their track record of paying on time with effective credit checking and monitoring.

How does credit risk affect cash flow?

When a business exposes themselves to a high level of credit risk, they increase the likelihood of late and non-payment.

Late payments will mess up cash flow forecasts, especially when payments are late by more than a month. This can cause huge problems if your business is light on cash reserves or if you’ve already allocated cash to a project based on expecting this payment to be made on time.

A total non-payment can be catastrophic for many businesses. It can be tempting to grant less favourable credit terms to a big customer putting in a huge order. The risk of non-payment might not even cross your mind, all you can think of is the value of the order and that cash hitting your bank. But what do you do if the cash never comes?

Businesses need to think about their options in the event of late or non-payments. You should ask yourself if you have enough cash reserves to absorb the hit of a late payment, set out a plan to chase late invoices and have a plan for the worst case scenario and how you’ll recover unpaid commercial debts.

Not receiving cash you’ve expected and forecasted means you’re less agile, makes it much harder to plan for the future and can impact on pre-existing plans that require this cash to invest.

Steps to avoid credit risk...

We’ve established what credit risk is and the negative impacts it can have on your business. The good news is there’s steps you can take to at least mitigate some of the credit risk you’re exposed to.

Doing business today is amazing, we have access to so many tools at our fingers tips that used to only be accessible by huge multi-national corporations.

Invoice Finance

Invoice finance gives businesses the opportunity to get a cash injection from their outstanding invoices. It works by allowing businesses to borrow cash against the value of these invoices that they’re waiting on being paid.

Optimum Finance advance up to 90% of your invoice value. Your customer would then pay the invoice directly to Optimum who will then pay you the remaining amount less their service fee.

Taking out invoice finance shields you from credit risk as you have the option to access a large portion of your outstanding invoice amount when you need it, meaning you’re less reliant on your customer for cash. This gives you some flexibility to allocate funds weeks or months earlier than expected, a great option if you have outstanding invoices but need cash fast for emergencies or rapid expansion.

Optimum can also supply a credit control team to chase your due and overdue payments and offer debtor protection as insurance against non-payment. These additions can completely remove the stress and worry of putting your credit risk in the hands of your customers. You can capitalise on the sales you’ve already made without having the worry of it coming back to bite you should your customers not come through on their promises to you.

Effective credit checking and monitoring

Excellent credit management begins right at the beginning of the process – with great credit checking and monitoring.

Always being in the know and kept up to date with changes to your customer’s credit file minimises the credit risk you’re exposed to and you’ll be able to make more informed credit decisions.

Setting appropriate credit terms

This is an important point as in most cases you can take the lead on setting out the credit terms, such as the value of credit offered and when the full amount needs to be paid - don't leave yourself vulnerable by offering terms that don’t suit you.

From time to time, such as if you have a big company placing a large order, you’ll need to be flexible on your payment terms. This is okay, as long as setting extended payment terms doesn’t leave you vulnerable to cash flow problems and you have a plan in place for if the payment terms aren’t met. Unfortunately, even huge respected international companies can have a track record of late payments.

Automating your full credit control process

Even with the most stringent credit checks, late payments can still happen and catch you off guard. When this happens it’s important to act quickly and have a plan on how you’re going to chase late payment and recover unpaid commercial debt.

Speak to the team at Optimum Finance today for more info on protecting your business from credit risk and keep it floating.