Customer risk is a major concern for CFOs and credit managers alike. But customer risk management also concerns sales and debt collection staff. The reason why customer risk is so important is that it has a direct impact on a company’s cash flow. In the event of late payment or non-payment, the company’s working capital requirement (WCR) increases. In the long term, this can lead to cash-flow problems and jeopardize the company’s long-term viability. To avoid this, you need to be aware of the various causes of customer risk, such as a missed payment, customer payment difficulties, or a dispute linked to a service or delivery. You will then be in a position to develop different strategies to reduce customer risk.
Identifying customer risk
Good customer risk management means identifying customer-related risks as early as possible. Customer risk management therefore involves determining whether non-payment is due to :
- a simple late payment. The causes of late payment may be involuntary, such as an oversight or error on the part of the accounting department, or voluntary, such as when the customer is experiencing cash-flow difficulties;
- an unpaid invoice, i.e. it’s not a simple delay. In other words, it’s not just a simple late payment. This is the case, for example, when an unhappy customer refuses to pay the invoice because he feels he has not received the agreed service or goods. It may also be the case if the company is experiencing major financial difficulties close to suspension of payments;
- the loss of a customer. Here, the dispute between the company and the customer is such that the latter terminates the relationship.
So, by quickly identifying the nature of the customer risk, you can find the most suitable solution for obtaining payment of the debt.
Customer risk assessment
Another highly effective way of limiting customer risk is to carry out a customer risk assessment. There are several methods and tools at your disposal. First of all, you can use the predictive method to anticipate customer behavior. This method is based on a precise analysis of information, data and past events. This analysis of the past provides a better understanding of the causes and consequences of customer risk within the company, based on the profile of its target clientele.
As a result, the company is in a position to take informed measures to determine the collection policy to be put in place. Customer risk is also assessed at the micro level, i.e. for each individual customer. Right from the start of the relationship, you need to assess the customer’s creditworthiness. To gather relevant information, you can consult Sirene notices or the infogreffe website. What’s more, if your customer has agreed to publish his accounts, you have access to a wealth of very interesting data. To assess a customer’s risk, you need to analyze his or her financial situation through various indicators, such as :
- Gearing, which in principle should be less than 1, but this will depend on the business sector;
- the general solvency ratio, which reflects the company’s ability to pay its debts with its own assets;
- Ebitda, which highlights profit levels;
- the DPO for Days of Payables Outstanding, which uses the balance sheet to determine how long it usually takes to pay supplier invoices.
Then, in the course of your relationship with the customer, you can also calculate the Day Sales Outstanding (DSO), the average time in which the customer pays you. The shorter the DSO, the lower the customer risk. All these elements will enable you to establish a customer score representing the risk represented by each customer. Depending on the score obtained, you’ll be able to adapt your payment terms and deadlines. If necessary, you’ll also be able to personalize customer reminders.
Customer risk management
Risk management is a subtle exercise that is not limited to financial management or cash flow management. The human and commercial aspects must also be taken into consideration. For example, customer receivables management involves setting up a customer collection policy and risk management procedures. This includes :
- define customer payment terms according to the risk of non-payment they represent. This period must be clearly indicated in all contractual and accounting documents (general sales conditions, quotations and invoices);
- manage outstanding receivables and, if necessary, limit them;
- setting up alerts in the event of late payment, in order to be reactive;
- customer reminder management, with clear scenarios to be applied according to the customer’s profile and the information he provides;
- set up a collection process to trigger the dispatch of formal notice at the right time, and refer the case for legal collection if necessary.
On the other hand, managing customer risk requires adopting the right posture towards the customer. You need to be firm in your demand to honor payment of the invoice issued, but you also need to maintain communication with the customer. Of course, the objective is to recover unpaid invoices. However, the preservation of the business relationship must not be overlooked.
Good communication with customers is therefore the key to successful collection, and consequently to good customer risk management. It will also help build customer loyalty and recover customers at risk. Indeed, even if a customer represents a risk, the company may still wish to work with him or her. It is then possible to negotiate payment terms with the customer that are adapted to his or her current profile, and which can evolve over time if the relationship goes well. Similarly, loyal customers with a very good score can benefit from more advantageous conditions, such as longer payment terms. This is generally much appreciated.
Preventing and reducing customer risk
To prevent and therefore reduce customer risk, the company has several levers at its disposal. Ideally, all of them should be activated, in order to optimize customer risk management. First and foremost, it’s a good idea to train employees who come into contact with customers in methods of communication and, in particular, dispute management. This applies equally to sales staff and debt collectors. In this way, they are able to adopt the right behaviors when presenting sales conditions, or carrying out reminders, for example.
Training teams and raising their awareness of the cash culture is also an excellent way of drawing their attention to the importance of receivables management for the company’s future. In addition, you can also educate and raise awareness among customers, to help them realize the risks they are taking in the event of late or unpaid invoices. For example, their customer account may be blocked and they will no longer be able to place orders, which can lead to business paralysis in some cases.
Similarly, they are liable to interest and late payment penalties if the invoice payment date is exceeded. Finally, in the event of repeated late payment, the company can reduce payment terms and demand cash payment, which can be very restrictive for the customer. The final lever for reducing customer risk is the use of debt collection software. Debt collection software automates the collection process. As soon as a delay is detected, the reminder scenario is triggered in accordance with the parameters set by the company.
Only the most complex cases are handled by the accounting department or collection staff. In addition to saving time, the use of debt collection software enables you to visualize anomalies and the financial situation thanks to the dashboard. For example, CashOnTime is a complete solution, published by DIMO Software, which structures receivables management from the automation of collection processing to debt recovery. Credit management, collection, litigation and lettering solutions are at the heart of this collection software.
Conclusion
Customer risk must be taken into account in the overall management of a company, and more particularly in its cash management. Taking a proactive approach to customer risk means reducing risk by intervening as early as possible. To do this, you need to be able to assess risks, and apply collection procedures reactively. This is why the use of collection software is highly recommended for effective customer risk management.
Find out how using collection software can reduce customer risk.
