Credit & Debit Basics
What are Creditors and Debtors?
Creditors are the people to whom we owe money for goods and services supplied by them to us on credit.
A debtor is a person or entity that owes an amount of money.
What is the difference between accounts payable and accounts receivable?
The definition of accounts receivable is the money due from all customers for merchandise or services delivered on credit. The total figure would be shown on the balance sheet as an asset.
If you plan to sell goods or services on account in your business, you’ll need a method of tracking who owes you how much and when it’s due. Here are five key components of a good accounts receivable system:
- Verify accounts receivable balances. Use source documents such as invoices to keep balances accurate.
- Send accurate and timely invoices. You won’t get paid until you send an accurate invoice.
- Generate accounts receivable reports. This will help determine which customers are past due and help you track credit limits.
- Post the paid invoices. It’s important to track who pays you when.
- Match your records. Your customer records totals must match your general ledger and sub ledgers.
Need Credit?
What is trade credit?
For many businesses, trade credit is an essential tool for financing growth. Trade credit is the credit extended to you by suppliers who let you buy now and pay later. Any time you take delivery of materials, equipment or other valuables without paying cash on the spot, you’re using trade credit.
How to use trade credit
When you’re first starting your business, however, suppliers are most likely not going to offer you trade credit. They are going to want to make every order COD (cash or cheque on delivery) or paid by credit card in advance until you have established that you can pay your bills on time. While this is a fairly normal practice, you can still try and negotiate trade credit with suppliers. One of the things that will help you in these negotiations is a properly prepared financial plan.
When you visit your supplier to set up your order during your start-up period, ask to speak directly to the owner of the business if it’s a small company.
If it’s a larger business, ask to speak to the CFO or any other person who approves credit. Introduce yourself. Show the officer the financial plan you have prepared. Tell the owner or financial officer about your business, and explain that you need to get your first orders on credit in order to launch your venture.
Terms around trade credit
Depending on the terms available from your suppliers, the cost of trade credit can be quite high. For example, assume you make a purchase from a supplier who decides to extend credit to you. The terms the supplier offers you are two percent cash discount with 10 days and a net date of 30 days.
Essentially, the supplier is saying that if you pay within 10 days, the purchase price will be discounted by two percent. On the other hand, by forfeiting the two percent discount, you’re able to use your money for 20 more days.
On an annualised basis, this is actually costing you 36 % of the total cost of the items you are purchasing from this supplier! (360 divided by 20 days = 18 times per year without discount); 18 x 2 percent discount = 36 percent discount missed.)
Cash discounts
Cash discounts aren’t the only factor you have to consider in the equation. There are also late-payment or delinquency penalties should you extend payment beyond the agreed-upon terms. These can usually run between one and two percent on a monthly basis. If you miss your net payment date for an entire year, that can cost you as much as 12 to 24 percent in penalty interest.
Effective use of trade credit requires intelligent planning to avoid unnecessary costs through forfeiture of cash discounts or the incurring of delinquency penalties. But every business should take full advantage of trade that is available without additional cost in order to reduce its need for capital from other sources.
Want to Extend Credit?
How to extend credit to customers
Working with big companies means you are working for clients who generally have a great deal of “red tape” to go through when outsourcing jobs to other companies. This can cause a situation that boils down to lots of paperwork and confused communication. Slow and late paying clients can drain your resources and are a major source of frustration.
Check Credit Ratings
Before agreeing to provide any services, check out the credit rating the company, before doing business with them. The credit report will highlight trends in your prospect’s payment history.
This information will assist you in determining the payment terms. For instance, if the prospect has a particularly bad credit score, you should only undertake work from them on a payment upfront basis. TransUnion or Experian will be able to supply you with a credit report.
Implement an order system and stick to it
Follow these steps in order to ensure a smooth working process when you agree to provide services for a new company.
- Provide a quotation: When working out a quote for services you provide, you need to know exactly how much time the job will take and precisely what your time is worth. Keep accurate and detailed records of the time you spend on various tasks. It might seem like a hassle at first, but quickly becomes part of your normal routine. Follow good customer service principles and deliver your quotes when you promise you will
- Once the quote has been accepted issue a job order: The job order must be signed by the person in charge before work can proceed. Be prepared to discuss details of the job order and make yourself available to do so. Always make any amendments in writing.
- When the work is complete and the client satisfied, an invoice can be issued to the client
What is a Job Order?
A signed job order reflects both sides’ agreement about the work that is to be provided. If you don’t perform the work, the other side need not pay you. If you perform work, according to the specifications of the job order, you will be able to issue an invoice and receive payment.
The work order should include payment provisions and all the necessary terms and conditions. For an order to be legally binding it must be signed by the company that is contracting the work from your company.
Contracts: Terms and Conditions
Make sure that the terms and conditions appear on the order form and the invoice spells out the grace period within which a client make payment after the invoicing date. The standard practice is 30 days, but you can determine this according to your needs. Also explain that interest will be charged for late payments.
You could also consider a discount for COD payments. This will give incentive to your clients to pay their invoices sooner rather than later. Most clients will act in good faith, so keep an open mind, and be willing to negotiate in instances where there is disagreement. However, by explicitly setting the terms in advance, potential disputes can be avoided and you can focus on what’s most important – doing great work.
Dealing with Non-Payment
Getting paid
Send reminders via email or fax to the contractor for payment. If you have had no response from the reminders, then you must send a final demand. You usually send three reminders. Keep copies and proof that these have been sent and received by the party that owes you money.
Even after you’ve sent a number of statements and reminder notices, some customers will continue to ignore you. This is the time to hire outside collection agencies, which will use stern and firmer methods such as listing them with credit bureaus. Many customers fear damaging their credit rating, so the simple act of being contacted by an external third party is often enough to worry many customers into action and to pay you.
What does the contract say?
“So much depends on the agreement between yourselves and the contractors. Was the service provided on a cash payment or did you agree to accept payment in 30 days? It’s hard to comment without understanding the terms of payment and what was agreed to within the contract,” says Cheryl Burns, Marketing Manager, Lombard’s Insurance.
Remedies
In order to avoid similar situations in the future, you can take few steps.
Before you agree to do any work for a company, do a credit check and ensure that they are in a position to pay you. Consider investing in Trade Credit Insurance also known as business credit insurance. Trade credit insurance usually covers a portfolio of buyers (debtor’s book) and pays an agreed percentage of an invoice or receivable that remains unpaid because of protracted default, insolvency, or bankruptcy.
How to handle bad payers
The National Credit Act has established guidelines for dealing with delinquent debtors, but you have to work through a credit bureau.
List the defaulting debtor
You can use list a defaulting debtor with a Credit Bureau so that details of their debt appear as an “adverse listing” in the national credit databases. But this must be done in strict accordance with the terms set out in the National Credit Act.
The process
Once you have completed the collection process and have had little success, you have little choice but to list them. If you decide to list a defaulting debtor, the first step is to notify them in writing that they will be listed. “They have 20 days in which to respond”, explains Ethel Titus of Experian. “If they don’t respond to the registered letter, then contact either Experian or TransUnion or both, and request an Adverse Form”, advises Titus.
Free listing
The Adverse Form must be completed and returned to the credit bureau that will in turn check if the delinquent company is already listed. If some form of information on that company does reflect on the credit bureau’s records, they will attach your adverse listing to that report free of charge.
Create a file
“If the delinquent company has not yet been listed then the procedure is different”, says Titus. “You have to contact a business consultant at a credit bureau and arrange to create a file for the defaulting company. There is a fee to do this and once paid, the delinquent company will be listed.” Approach TransUnion or Experian, South Africa’s major consumer credit reporting bureaus and they will guide you.