When you think about your company’s Accounts Receivables and Accounts Payable portfolios, you aren’t just thinking about the money that’s immediately coming and going. You’re projecting and planning for the future based on what you know about your customers. Is spending more on fulfilling a rush order for your company going to be a problem for a customer given that they have upcoming loan payments that will be a priority to pay? Has a customer lost several of their customers who account for a significant portion of their annual revenue? These are things you need to ask yourself so you don’t end up getting stuck with a customer who consistently pays your invoices late.
When you start working with a new customer, you need to understand their business at every level.
Sure, you’ve pulled your potential new customer’s business credit report and looked at their credit score and credit limit. And you’ve probably spoken to key stakeholders and customer references too (or at least we hope you have). But the companies you work with can make or break your own business – shouldn't you be extra sure you have the full picture?
Customer payment data gives you a glimpse behind the curtain of your customers' Accounts Payable function. You can see how they’re paying their bills. More specifically, you can see how long they typically take to pay vendor invoices. You can see if their payments are taking longer than usual, which could indicate cash flow issues.
But even though customer payment data gives you valuable information, it still doesn’t tell the whole story. When you cross-reference your customers’ payment data with their financials, you can see if other factors could lead to you not getting paid on time (i.e. declining sales, growing debt, available credit).
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1. Accurately forecast customer payments
Thea Dudley has over 30 years of credit management experience and acts as a credit and financial management consultant for major building material dealers and construction companies. She warns about thinking that a company is ‘too big to fail’ and not cross-referencing payment data against financials. “Using only one source for a credit review or in opening an account is a dangerous practice,” Thea explains. “If you’re able to cross-reference financials with a business credit report, you can garner information you might not otherwise have.” For example, if the business has a low inventory turnover, it could be a sign that they’ve overstocked themselves. That, combined with a high accounts receivable turnover and a slow accounts payable process, points to issues with liquidity.
Forecasting is crucial to your company’s future success. It’s one thing to be in a good position right now. But if you don’t accurately predict what your customers will be able to do for you in the future, you could quickly find yourself in the red.
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2. Anticipate cash flow issues and the risk of bankruptcy
Wouldn’t it be nice if you had a crystal ball that could tell you for sure that your customers were doing well, had strong cash flow and would stay open for years to come? Of course, because then you’d be able to anticipate that revenue and grow your bottom line. But life and business don’t work that way.
Just because a customer has a strong credit score or a good track record of paying their bills when you first signed a contract with them doesn’t mean that will always be the case. Things happen. Circumstances change.
Your customers might not have done enough cash flow forecasting and find themselves struggling to pay invoices on time. It’s also possible that debt has grown so much that it’s putting pressure on your customer’s finances – meaning they may have to prioritize paying down debts before they can pay your company’s invoices. And then there’s the possibility that your customers might be in a heavily saturated, highly competitive market and can’t keep up with the competition – causing them to lose business and revenue. All these things are possibilities – and all of them can put a strain on your customers’ cash flow, which could mean your company doesn’t get paid on time. It could also become one of many factors that could push a customer to close their business or file for bankruptcy.
Cross-referencing customer payment data against financials gives you the full picture – and that can include the things customers would rather you didn’t know. Think about the cash conversion cycle (CCC) -- how long does your customer take to convert inventory into cash flow? The shorter that cycle lasts, the less time cash is tied up in Accounts Receivable or inventory and the more quickly you can expect to be paid.
When you look at a company’s financials, metrics like revenue and cost of goods sold (COGS), accounts receivable and accounts payable and the inventory at the beginning and end of the financial period are key. Is the company selling their inventory? Does it seem like they’ll continue in good standing with their creditors and customers?
“Look at what supports the story of the credit report,” Dudley recommends. When you're looking at a customer’s financials, you can look at things like debt. A report by S&P Global found that corporate debt defaults increased by 80% in 2023. So, how can you be sure that the businesses you work with aren’t struggling under mounting corporate debt?
We’ve talked about the rising debt problem businesses are facing, with our research on rising debt revealing that 58% of businesses had their long-term debt increase in the last 12 months. Look into the debt your customers have. While it’s normal for businesses to carry long-term debt, that doesn’t mean that all debt is created equal.
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3. Make segmenting your AR portfolio more effective
A company’s DSO, or Days Sales Outstanding, reflects how quickly they’re being paid by their customers. In our research study Perils of Rising Debt and DSO, we uncovered a worrying trend when it comes to DSO: 57% of the surveyed businesses saw their DSO increase in the last 12 months.
“If a company has good cash flow, but their credit report is showing they pay beyond terms (i.e. late), you need to think about why that could be,” Dudley says. Is it a strategy or system the company put in place intentionally or are there deeper issues when it comes to debt or the structure of the business itself?
When it comes to lowering your own business’ DSO, prioritizing collections is key. And when you’re trying to segment or prioritize within your AR portfolio, you need the full picture of your customers to figure out where you priorities should be. If they pay late, but they pay consistently, it might not be a problem for your company. Instead, you can factor those later payments into your forecasting. But if their payments are inconsistent, or if their financial data doesn’t align with the picture their payment data paints, you may need to take a second look at the relationship.
Segmenting your AR portfolio based on payment history or risk can help you better allocate resources. That way, your team can spend more of their time on bigger issues and, ultimately, improve your cash flow.
About the Author
Lina Chindamo, Director, Enterprise Accounts, Canada, Creditsafe
Lina Chindamo is currently Director, Enterprise Accounts at Creditsafe Canada, and a Certified Credit Professional (CCP) with over 25 years of experience in credit risk management. She has held senior leadership roles with leading companies in multiple industries in the Canadian market such as Sony Electronics, Maple Leaf Foods, and Mondelez Canada. Her experience as a credit professional along with her current role as Director, Enterprise Accounts who works closely with c-suite partners and credit teams across all industries makes her a well-rounded credit professional who is well respected in our industry.