4. Evaluate your customers systematically

Recent years have seen a gradual rise in insolvency in most advanced markets. The knock-on effect could be far-reaching and adversely impact the creditworthiness of your new and existing customers alike. To avoid delayed payments and non-payment cutting into your margins, it is critical to monitor your customers' creditworthiness on a frequent basis. Any unfavourable information such as defaults and court judgements could potentially mean deterioration in your customers' payment behaviour.

A system for rating the credit risk your customers incur is indispensable here. It can help your credit team flag possibly problematic accounts receivable and inform sales in time. The credit risk rating system can vary considerably between organisations; however, you can use the five-tiered system below as a baseline.

1. Excellent. The customers are large-scale enterprises. They are in a strong financial position and present low to no credit risk. The only factors that could affect their payment behaviour are weak macroeconomic conditions, and errors in your sales and administration processes (mistakes in contracting, invoicing, shipping, or the likes).

2. Good. The customers are smaller compared to "Excellent" customers. They are in a solid financial position and present low to no credit risk. The factors that could affect their payment behaviour are weak microeconomic and macroeconomic conditions, and errors in your sales and administration processes.

3. Fair. The customers are in a relatively secure financial position and present low credit risk. There are many factors that could affect their payment behaviour. However, in general, they pay their invoices after a few reminders and follow-ups. Most of your customers would usually have this rating, making it the tier where your accounts receivable team spends the most time on.

4. Poor. The customers are in a weak financial position and present considerable credit risk. It takes much longer and much more effort to get them to pay compared to the "Fair" customers. As a result, this is the tier where your accounts receivable team puts most energies into. It is possible to extend credit to "Poor" customers, on the condition that sales go through the credit approval process to assess whether taking the risk is worth it. In the event that "Poor" customers are granted credit, the credit team needs to monitor them closely and notify sales when their creditworthiness changes.

5. Bleak. The customers are in a difficult financial position and present high credit risk. They often have a track record of defaulting on payments or having legal issues. It is still possible to sell to "Bleak" customers, but special measures need to be taken to protect profit margins. For example, sales can only be made on strict prepayment terms.

Naturally, you would check the creditworthiness of "Bleak" and "Poor" customers more frequently than "Fair" customers, and maybe not check the "Good" and "Excellent" customers at all. But it is essential to make a point of keeping tabs on all of them routinely, because many food and beverage companies tend to use their suppliers to maintain their own cash flow. This can happen for various reasons: it is easier to delay payments than to make new sales, the suppliers may not pursue collections for fear of ruining the trade relationships, and it is not easy or quick to make changes in the supply chain anyway.

You may also want to have a "Blacklist" rating for customers who are in default repeatedly. As they continuously put pressure on your cash flow, you may consider not extending credit to them until they pay all their outstanding invoices.

Having a structured, regularly updated oversight of the creditworthiness and payment behaviour of your customers gives you an instant idea of the composition of your accounts receivable portfolio, where cash flow is held up, and what courses of action you could take to improve it.

On the next page: Aim for financial flexibility