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How due diligence on your debtors can protect your business cash flow.

Learn how due diligence on your customers can help you manage your business cash flow.

It’s not uncommon for businesses to struggle with cash flow. But when it's your customers that are the biggest culprits of your tight cash flow, things can get a little trickier. This is why conducting your due diligence on the customers you sell to on credit is critical as a business owner. 

Selling to your customers on credit terms is the same as lending them money - without the interest. You provide them with products or services today in the expectation that they will pay you according to the credit terms you have agreed. Just as you would like to understand the credit worthiness of someone you are lending money to, you should also understand the credit worthiness of businesses you are selling to on credit.

Due diligence on debtors is about gathering as much information as possible about the financial state of new clients and continuing to assess their ability to pay throughout the trading relationship. Understanding their ability to pay also allows you to think about your own cash flow analysis with more confidence.

What is debtor due diligence?

Put simply, doing your initial due diligence means carrying out thorough research on your customer before you begin to supply goods or services. Ideally, you'll want to have evidence that the company you're about to work with - aka your soon-to-be debtors - have a reputation for paying their suppliers and the financial resources to do so.

Exactly how you assess the financial capability of your clients depends on the resources of your business and the level of risk you're willing to accept and would ideally include most of the information below:

  • Profit and loss statements and balance sheets.
  • Legal and financial concerns including history of bankruptcy or regular late payments.
  • Historical records and future projections.
  • Recommendations or references from current or past customers. 

For many small businesses accessing all of this information can be next to impossible, not least because large customers may be unwilling to hand over this information to a small supplier. And even if the information could be sourced, analysing the information properly would require a financial or legal expert.

Asking around the industry to understand the reliability of customers should be a minimum for all business owners and fortunately there is an easy way to get help with the nitty gritty of your due diligence without too much cost. Credit agencies such as Equifax and Creditorwatch provide reports that can help you to check the credit worthiness of your debtors when conducting initial due diligence on a new customer as well as for keeping tabs on them throughout your relationship.

Making decisions following due diligence

Thorough due diligence on your customers can save a lot of headaches by minimising the risk of non-payment and can also guide you on the best payment arrangements you have with your debtors. 

For example, if a potential new customer has a less than perfect credit history you may still provide your goods or services to them but insist on full payment upfront or at least a hefty deposit. 

The flipside is that you may choose to supply a new customer on extended credit terms because of their stellar credit history and reputation.

A detailed knowledge of your customers can provide the information needed to make educated decisions that will allow you to protect and grow your business.

Trade credit insurance

Trade credit insurance is an insurance policy that protects your accounts receivable from the default of your customers. For most small businesses, the debtor’s ledger accounts for roughly 40% of its total assets, which makes it a huge chunk of most businesses' working capital. 

Without trade credit insurance, your business could be subject to significant monetary losses, should any of your clients be forced to go out of business. 

This cost of trade credit insurance will vary depending on the type of policy you opt for, the industry you and your debtors are in, and your business' annual turnover but it is seen by many business owners as an essential part of business risk management. For more information on trade credit insurance, contact Australia's leading trade credit insurance broker NCI.com.au.

How does due diligence help small business cash flow

Taking measures to protect the expected cash flow from your accounts receivable ledger is good business sense and failing to do so has led to the downfall of many otherwise successful businesses. Depending on the concentration of your debtor ledger, which is another critically important risk discussed here, the failure of just one of your clients can put your entire business at risk so it's definitely a risk worth mitigating.

Paradoxically, it's often the customers with the best credit quality that also push the limits when it comes to slow-paying their invoices. To close the cash flow gap between paying your business costs and receiving payment from these slow paying customers, invoice financing can be a helpful tool. Companies like Earlypay can advance around 80% of the value of your outstanding invoices upfront and can also provide services to help with collections and can arrange trade credit insurance.

If you would like to learn more about cash flow support to see if it's right for your business, please contact our team today on 1300 760 205 or enter your details into our sign-up form and we will get back to you ASAP.