Reducing Risk in a Receivables Portfolio
With many businesses seeking extended payment terms to nurture growth, a receivables portfolio has become much more common. Receivables are created by extending a line of credit to customers and are reported as current assets on a company’s portfolio. They are considered a liquid asset, because they can be used as collateral to secure a loan to help meet short-term obligations.
An important concept to discuss when talking about a receivables portfolio is the riskiness involved in offering credit to customers. There may be potential for a certain customer becomes to be unable to meet the obligations of that extended credit. If the customer is an important one, it will have major repercussions on the business and can even lead to bankruptcy. For example: if a company has $2 million in its receivables portfolio and the biggest customer represents over half of that amount, let’s say two thirds at $1.3million; this customer defaulting and being unable to pay will have a colossal impact on the business. Because of this, reducing risk is imperative to any business and here are some tips on how it can be done:
Reducing the concentration ratio:
The concentration ratio helps evaluate the number of companies that owe you money, how much each company owes and how much they owe relative to each other. The more concentrated the portfolio is, the greater the risk because of the potential impact. Reducing the concentration ratio would mean that any potential fallout does not harm the business as much.
Standardized systems to track/ follow up on accounts receivable
In dealing with all other aspects of accounts receivables, it is quite easy to get side-tracked. Whoever oversees the finance, it is essential to organize the lists of customers and due dates. It is also important to set up a system for all transactions and processes to be efficient and manageable.
Offering benefits to incentivise early payment/Factoring:
Offering discounts to customers to help incentivise them to pay early can strongly decrease any risk that is involved with a receivables portfolio. For example, if a large customer wished to purchase in bulk, a ten percent discount could be offered if they payed in advance. A solution that Convergence offers is dynamic discounting which follows this idea. If customers pays early for a discount, then the purchase isn’t added to the receivables portfolio in the first place and is liquid cash in your hands.
Factoring is very similar. To do this, you sell your receivable to a factoring company for its cash value, minus a discount. This gives you your money immediately because you don’t have to wait for payment—the customer will pay the factoring company instead of you.
Having a strong relationship with customers and understanding their business operations:
This is often overlooked. Having strong relationships with customers will mean that customers are less likely to miss out on payments and are more incentivised to deliver on what they promised. Furthermore, understanding the market and how their business operates can help you prepare in advance if there are likely to be any issues. In addition to this, it is strongly advised to carry out a complete background check or internal “KYC’ of new buyers before agreeing to extend payment terms.
Having Insurance:
While insurance can be costly, it can have tremendous value in protecting a receivables portfolio. Trade credit insurance is purchased by businesses to insure their receivables portfolios from loss due to the insolvency of the customers. It is simply a layer of protection from any issues that may arise in payments.
