Practical Steps for SMEs to Start with Debtor Analysis

Debtor analysis is a significant component of any SME (Small and Medium Enterprises) financial management. Understanding customers’ payment status is a crucial way to maintain healthy cash flow and guarantee business survival. SMEs usually face many problems in collecting overdue debts. This can hugely affect the smooth operation of such businesses. Debtor analysis provides SMEs with critical knowledge regarding their receivables and thus develops a more efficient means of dealing with them. The rest of the article explores the concrete actions an SME could undertake to initiate debtor analysis.

Understand the Importance of Debtor Analysis

Before discussing the specifics of debtor analysis in-depth, understand why it matters. Debtor analysis helps analyse SMEs’ potential cash flows by checking into customers creditworthiness, noting trends in payment, and perceiving the risks of not paying on time. Based on this type of analysis, businesses can work proactively to remind or modify credit terms for at-risk customers. This way, SMEs will avoid bad debts, reduce the risk of delayed payments, and improve their financial health.

Set Clear Credit Policies

Clearly stated, transparent, and documented credit policies form some of the early measures for successful debtor analysis. This includes stipulation of credit terms such as the terms for paying, rates applicable to overdue amounts, and conditions guiding the granting of credits. For an SME, such credit policy may further dictate how much one will extend by which customer profiles or history. By having such policies in place, the company can ensure it is granting credit only to a reliable customer who can repay debts within a reasonable period.

Key Elements of Credit Policies:

  • Credit Limits: Define a maximum limit that can be extended to each customer.
  • Payment Terms: Decide on the standard payment period, e.g., net 30 days, 60 days, or 90 days.
  • Interest on Overdue Debts: Set penalties or interest charges for overdue payments to encourage timely payments.
  • Credit Approval Process: Establish a procedure for assessing and approving new customers or increasing credit limits for existing customers.

Create a Comprehensive Debtor Database

A good debtor analysis requires an adequate and updated database of all customers and their transactions. This database needs to include the following:

  • Credit limits and terms for each customer
  • Historical payment patterns
  • Any previous instances of late payments or defaults
  • Current outstanding amounts and ageing of debts

A good debtor database ensures that businesses get all the information about a customer’s history of pay behaviour and creditworthiness upon immediate request. It also permits tracing trends or problems in a customer’s history, which may indicate a problem ahead.

Classify Debtors Based on Ageing Reports

Practical debtor analysis involves the regular study of an ageing report, where outstanding invoices are categorised according to the weeks they have been due. The ageing report helps SMEs see what debts are outstanding and at what level, thus guiding the identification of arrears and the prioritisation of collection.

Typically, debts are classified into the following categories:

  • Current: Debts that are within the agreed-upon payment terms.
  • 1-30 Days Overdue: Debts that are slightly overdue but not yet significantly problematic.
  • 31-60 Days Overdue: Debts are becoming a cause for concern and require follow-up.
  • 61-90 Days Overdue: Delinquent debts should be addressed urgently.
  • Over 90 Days Overdue: Seriously overdue debts, often requiring legal action or external collection services.

In most cases, an SME can observe how its debtors are performing and take proper actions based on the severity of the overdue amount if it continuously produces ageing reports. Proactive follow-ups and reminders should be communicated to customers in 31-60 or 61-90 days categories.

Monitor Payment Trends and Customer Behaviour

Debtor analysis is not just about monitoring what is happening now with accounts receivable but also about tracking trends in long-term payments. The SME should always review payment behaviour over time, looking for patterns indicating a potential future problem. For example:

  • Does a customer consistently pay late but within an acceptable range?
  • Have customers suddenly stopped paying or have frequent invoice disputes?
  • Are certain sectors or industries more prone to late payments?

Communicate Effectively with Customers

Debtor management requires an open communication system with customers. SMEs should send timely reminders before and after the payment due date. Effective email or phone reminders can help ensure timely payments. Moreover, amiable yet assertive communication ensures that customers appreciate the value of timely payments without hampering the relationship.

If a payment is delayed, SMEs should engage with the customer immediately. Early intervention allows the business to resolve any issues before the debt becomes more difficult to recover. For customers facing genuine financial difficulties, a payment plan or temporary extension of terms may be negotiated to ensure continued business relations.

Implement Debt Collection Procedures

A well-defined debt collection process should be implemented for SMEs with substantial overdue debts. The procedure should outline steps to follow when a customer fails to pay on time, such as:

  1. Friendly Reminder: A gentle nudge, either by phone or email, to remind the customer of the outstanding payment.
  2. Second Reminder: A firmer reminder indicating the risk of further action if the debt is not settled soon.
  3. Formal Letter: A more formal approach stating the consequences of non-payment, which may include legal action.
  4. Third-Party Collection: If internal efforts fail, SMEs can consider outsourcing the debt collection to a third-party agency or pursuing legal options.

By defining this process in advance, SMEs ensure a consistent and systematic approach to recovering debts.

Leverage Technology and Tools

SMEs are increasingly implementing accounting software and debtor management tools by more and more SMEs to help them analyse debtors more easily.  Business software packages for SMEs often include features like automated ageing reports, due date tracking, and reminder alerts, which save time and allow focus on core business issues.

Besides this, CRM tools make it easier for businesses to manage communication and form better customer relations. A CRM system centralises payment tracking and communications management, making debtor management more efficient.

Regularly Review and Adjust Credit Terms

SMEs should monitor credit policies and debtor management at regular intervals to ensure debtor analysis does not become ineffective. At times, credit terms may need to be changed due to changes in business conditions or customer profiles. Businesses may have to reduce credit limits or provide for stricter payment if customers regularly make delayed payments or if their financial condition has changed.

Additionally, SMEs should be open to negotiating customised payment solutions for long-term or high-value customers facing temporary financial difficulties.

Conclusion

Debtor analysis is a strong tool that allows SMEs to manage their receivables efficiently, decrease the risk of bad debts, and improve cash flow. SMEs can ensure they have the right tools to keep their finances healthy by following the practical steps outlined above, such as clear credit policies, maintaining a debtor database, monitoring ageing reports, and effective communication and collection strategies. Being proactive and staying organised can significantly reduce the risk of late payments, leading to better financial stability and business growth.

Moreover, with the upcoming launch of the Pulse Debtor Analysis module, managing debtors will become even more manageable, helping SMEs stay organised and proactively manage their financial health for better growth and stability. Sign up to Pulse today so you’re among the first to know when it launches!

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