The Cost of Credit   Leave a comment

Have you any idea how much it costs to both use credit to aid cash-flow and grant it in turn to your clients?

It struck me that whilst we measure lots of aspects of credit management, this is something that we accept is just a necessary evil and therefore it tends to go unchecked.  After all it is said that if there was no credit, there would be very little business done in today’s world.

In an attempt to demonstrate to a client that it can be in fact be quite a drain on resources, especially if you’ve got an inadequate cash-flow forecast and you suddenly find yourself with a short term, temporary cash shortage, I prepared the following graph.  Left click on the image to see a larger version of the graph.

The hidden cost of credit
The hidden cost of credit

It shows the cost of borrowing £50,000 on both an agreed overdraft extension costing 7.46% interest and at the unauthorised overdraft level of 24.6% interest.  Even if only required for 30 days, the cost was £307 at the lower interest rate and a shocking £1011 at the higher.

I think this helps us to understand why inadvertently becoming a lender to your client for a period beyond the agreed terms is something to be avoided.  Many businesses no longer have agreed overdraft limits to call on, so taking longer to pay their creditors is a way of managing their own cash flow.  If you allow it, late payments may become the norm, adding to your own costs and reducing your profits.

So what can be done?

1.Risk profile clients at account inception to enable you to set up trading terms that protect your interests

2. Relationship manage so that you are in regular communication with clients

3. Manage your fees recovery activity so that the Days Sales Outstanding figure stays low

4. Forecast your cash-flow accurately so that you save on costs by removing the need for emergency cash

5. Don’t leave it until the last minute to ask for help – it’s invariably the most expensive when it’s urgent

If you would like to calculate how much using credit is costing your business, request our free cost of credit calculator by emailing “Cost of Credit” in the subject line to info@cmlawltd.com

Posted August 29, 2011 by Julie in General information

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