In the last economic downturn for your industry, did your bad debt increase materially? While on the surface, customers not paying may seem bad for business. It leads to lost revenue and potentially lost customers, which ultimately will hurt your bottom line. Yet, this increase in bad debt during the downturn can actually show that you are doing your job correctly.
Extending credit is not an exact science. You will never be 100% sure that you customer will pay you back. Credit departments are therefore in the business of risk management. Their job is to find the optimal amount of risk to increase sales, yet also minimize the amount of revenue lost to non payment.
Many managers will insist their credit departments minimize risk by only extending credit on strict terms and only to those who they are certain will pay. While this may decreases any potential loses, it also chains down your growth potential during times of economic prosperity.
When should you take risk
Taking risk can be great, but only when they are calculated and have the potential to pay off. During good economic times, it stands to reason that many potential customers will be doing well. During these times, businesses typically have more income and thus are far more likely to be able to pay on time. It is during these times that your credit department should be taking risk. This can not only increase short terms sales, but it can also build your customer base for long term growth.
Eventually through, the cyclical nature of the economy will lead to a downturn . Even if you have been taking the proper risk to grow your business, this will inevitably lead to an increase in customer debt. Business that used to be able to pay, may now find themselves in harsher economic times. Yet, an increase in non payment simply shows that you have been managing your credit department correctly. It means you did not shackle your growth potential during favorable economic conditions.
Does this work during bad economic times?
Like I said before, credit departments are in the business of risk management. In addition to taking risk in order to grow during good economic times, it also means knowing when the risk is too high for your business to take. During bad economic times, the likelihood that someone will not be able to pay is far greater and risk should be minimized. This is the time to tighten the reins and try to minimize loses until the economy turns around
As always, different business will experience different circumstances and no one policy will apply to everyone. I am not suggesting taking stupid risk just to get an extra buck, but growing your business requires risk and you should not be afraid to take smart, calculated decisions that may not pan out. Sometimes a customer not paying should be seen as a good sign and not a bad one.