To protect your money and ensure that you recover all your debts from the marketplace it is important to keep your ears to the ground. As a finance person it has always been my endeavour to listen to what is happening in the market to assess any potential risk of non-collection.
Today I would like to narrate a real-life incident which has served as a great learning for me and my team when extending credit in the market. Afterall, we become Pros after making mistakes and then use that learning to stop similar events recur. I was at that time working for a food distribution company which was extending credit to many players in the restaurant business. The credit terms extended by us as a group was 60 days from date of invoice. For the first 3 months we noticed that the average payment days observed by the restaurant was clocking 60 to 70 days. By average payment days I mean the average number of days used by the customer to pay from the invoice date. The ageing report reflected that his dues were in the 0-30 days bracket with no particular alarm signal.
In the next 3 months however the average payment days changed to 90 days although the credit period extended was only 60 days. I informed the sales person to check why there has been a dip in payment performance and to go and check whether the restaurant was in-fact doing well. He came and reported that the restaurant was really busy and that the management had assured that the payment delay was happening because their accounting system was not up to date. He also informed me that since the restaurant was doing so well the owners had decided to open 2 new outlets in other locations as well. This was indeed reassuring since opening up of new restaurant is a sign of a company doing well.
Few more months went by and the payment terms got worse from 90 days to 105 days. While we continued with our supplies it signalled a red flag in my credit department since the payment was getting delayed with passage of time though the restaurant was apparently doing well. It was necessary to meet the owners as this was increasing our exposure and expanding our cash conversion cycle.
What we found out after our several meetings was a great learning which can’t be picked up as a potential risk on face value.
The owners had decided to expand their business seeing the success of one restaurant. Due to lack of fixed capital and bank funding, they were using their working capital to fund the expansion. This led to shortage of money to run day to day operations. Also, their new outlets were buying stocks in the name of old outlet and no separate credit application form was filled up to cover for the credit for these new outlets. They said that they needed a payment plan to reduce the exposure on the credit limit. We had to reluctantly agree to ensure continuity of business and recovery of full money.
The key learning that we got out from this exposure is that if the parameters of credit are violated by the customer it is important to keep your ears close to the ground and pick up any possible rumblings that could affect your financial management and ultimately your risk of exposure. Growth is a great initiative and all companies love to cater to growing businesses. However, if we take our foot off the pedal, we could expose our own company in a major way.
The role of finance in today’s business environment has to undergo a major change. They need to become active business partners to business rather than providing back-office support. Understanding the business dynamics is therefore crucial. Let us not be blinded by the growth story of our customers and make our own homes unsafe. It is important to dig deep to evaluate how this growth has been financed. If it happens to be your money which is being used to finance this growth, beware and limit your exposure before it is too late.