What is Trade Credit and How to Manage? | Allianz Trade in Hong Kong (2024)

Trade credit refers to an agreement between twocompanies, where the supplier of goods or servicesaccepts a deferred payment from its client.​

Trade credit management refers to the process ofmanaging the credit extended to customers and the riskassociated with that credit. This includes tasks such ascredit application and analysis, credit limits, and collection.​

Effective trade credit management helps a company tominimize the risk of bad debt and maximize its workingcapital. This includes monitoring customer paymentpatterns, setting credit limits, and implementing creditcontrol procedures such as sending invoices andreminders. It also involves working closely with customersto resolve payment disputes or issues, and negotiatingpayment terms and conditions that are favorable to both thesupplier and the customer.​

Late payment and payment default situations happen with alarming frequency – it’s critical to the financial health of your company to minimize them. Customers who fail to pay their invoices or drag their feet in paying can directly jeopardize the survival of your business,which is why having a credit managementsystem is important.

Many businesses find it challenging to properly evaluate and track the creditworthiness of new customers. And when conducting business with foreign customers, customer risk management becomes even more complex because it can be difficult to interpret and rely on information used by foreign countries to measure creditworthiness.

Solving the challenge is a must: One in five business bankruptcies amongsmall-to-medium enterprises occurs due to customers that default on their invoices. And thoughmedium and large companiesare better equipped to absorb a bad debt loss, non-payment events can still destroy their profit and spoil growth plans.

By employing effective credit management procedures, you can help your business bring in the revenue it’s entitled to and ensure long-term business continuity.

When it comes to contracts, be sure to state in writing the delivery and payment conditions, and also discuss any provisions in the agreement. This is where you can indicate whether certain conditions apply and that you do not accept any other conditions. As a starting point, you can check with your trade association for the conditions typically used by your industry. Upon entering into the contract, we also advise asking a lawyer to review the conditions. It also may make sense to be up front with your customers and make them aware in your contract and invoicing that you are credit insured. Doing so makes clear that there are greater consequences in the event oflate paymentor non-payment.

Also, v​erify that the person who signs for each receipt has the proper authority and​ ask for a company stamp on the receipt.

• Your company name, address and telephone number along with a contact name
• The right company name and address of your customer and the right customer contact person
• The nature and quantity of the goods or services
• The price in the appropriate currency
• The agreed-upon payment period
• Your bank account number
• Also print your terms on the back of the invoice

If payment has not already been received, calling customers right before or on the due date of an unpaid invoice can be handled by the accounting department or the sales department, depending on the relationship with each customer. This call confirms the products you delivered and that the invoice has been received. In addition to facilitating the payment process, this step also provides good customer service to make sure everything is OK. This step can also prevent late payments if your cilent is not satisfied with the delievery - while there's still time to rectify the issue. You can even consider offering your customer a small discount if they pay by the due date.

Not all customers pay their bills within the agreed-upon payment period, so be sure to have an effective credit management policy for late payments. In the event of late payments, call the customer and follow up with a written reminder that you are expecting payment within a reasonable time, such as one week.

If payment still does not come through, you can then send a warning and eventually a formal written notice. This typically asks for payment within two business days and presents a specific date by which the money must be received before legal proceedings will commence. Given the costs associated with late payments, also consider adding fees to account for collection and interest costs.

In the event that you enter into an agreement for a late payment schedule, put the terms of the agreement in writing and clearly note the following:

• The total amount due
• The payment periods
• The specific dates on which payments must be received
• Your bank account number and other routing information—if payments will be wired/transferred electronically

With a credit management system , you should also monitor the customer’s progress. Are they complying with the rules? Is there any possibility they are on the verge of bankruptcy? Also, inform your credit rating agency. Late payments by your customer may have implications on your own creditworthiness, which underscores the importance of having a credit control procedure in place. Being credit insured means your carrier will handle follow-up and collections of late payments, which, in addition to saving you time and effort, can also help preserve your customer relationship by removing you from contentious discussions.

We advise researching new customers when you start talking to find out as much as possible about the company you’re doing business with. Consider various information sources for your customer credit analysis, such as the local Chamber of Commerce and credit bureaus, bank and trade references, company 10K, etc. Even existing customers should undergo periodic reviews. Being proactive during the research phase plays an important role in the credit management process.

Of course, the gold standard data for understanding your customers' financial position is their audited financial statements. Some privately held customers may be willing to share these with you upon request, but many will not. If you have a credit insurer, your odds of having indirect access to these statements increases - customers respect the market power of an insurer and they typically offer confidentiality agreements to put them at ease that specifics will not be shared with the end customer. A customer credit vetting tool likeAllianz Trade TradeScore can help. Learn the financial health of your customer today!

Communicate your credit management process to other departments within the company to ensure the tasks andresponsibilities of individuals in other departments are clear to everyone. In some cases, they may be able to play a key rolein collecting invoice payments. Also set clear limits on required actions from other departments and make peopleaccountable. Evaluate periodically as to how well your credit management process meets the needs of the organization.

Be sure to review each customer with afrequency that aligns with the perceived risk that the particular buyer presents and its potential for default. Be careful not to hold a bias because of personal relationships. Just because you have a good relationship with a customer, doesn’t meanthey won’t default.

The value of an effective credit management policy is sometimes underestimated: Done well, it avoids unnecessary risks, createsopportunities for improvement, and frees up your company’s working capital for critical business investments. It thus makessense to set ambitious goals and actions, measure your performance periodically, and apply change when necessary.

A few examples of objectives you can establish for strategic credit management:

• Identify the average Days Sales Outstanding in your industry.
• Lower your Days Sales Outstanding (average number of days invoices go unpaid) to X number of days within a given period (your findings from the objective above can help you determine a sensible benchmark).
• Reduce the number of bad debts and annual depreciation.
• Compare your results with those of industry peers.
• Maintain a healthy diversification of buyer portfolio.

As you put these tips and practices into use, keep in mind that credit management is not a one-off project. It’s a processyou must keep working on all year. With success, you can accelerate invoice payments and help optimize the workingcapital your organization has to work with. This creates funds your company can invest in the future and proves the value ofeffective credit management to the entire organization.

Many businesses work under the assumption that their customers will act in good faith and pay their invoices as soon as they’re received. Unfortunately, studies show that up to one-third of businesses pay their bills late . While some of the responsibility falls on the customer, your business may be making the following correctable mistakes that are affecting your ability to invoice and collect payments.

• Set clear payment terms and take the time to understand how their procedures align with your expectations.
• Make sure you have a signed written agreement that clarifies all expectations. This makes it harder for a customer to use confusion or misunderstanding as an excuse for non-payment.
• Learn if any specific information needs to be included or procedures followed when invoicing.
• Know whom to contact to address late-payments or other concerns.

If you want to receive payments quickly, you need to invoice quickly. Ideally, invoices should arrive immediately after delivery when a customer is most receptive to paying. Ensuring that invoices are complete and directed to the correct parties will also make your invoice harder to ignore.

Managing late payments from customers can be a balancing act. If you’re too passive and give customers a pass, you’re losing revenue, setting a bad precedent and encouraging them to ignore you. At the same time, charging late fees and interest, disrupting deliveries, sending out debt collectors or threatening legal action can turn customers off and cost you their business.

When collecting payments, be assertive but polite. Be ready to pick up the phone and include your sales team and account managers in the process. When they do pay, always send the customer a thank you to acknowledge receipt and maintain a good relationship.

Even a well-defined strategy can’t cover all risks. Credit insurance can help. Allianz Tradetrade credit insurerprovides your company accessto the most accurate information on customers, prospects, industries and countries. Our team of experts provides activemonitoring on all accounts, a structure and discipline for credit decision making, resources for collections and paymentwhen your insured customers fail to pay. Credit insurance takes the guesswork out of your company’s credit process, givingyou the confidence to safely grow your business at home or abroad.

Learn more about trade credit insurance from Allianz Trade to supplement your customer credit management process.