How to Deal with Risk Assessments in Accounts Receivables

The two most critical elements to your business health are your customers, and your cash flow.  When one or both of these get off-track, your business is at risk. A thorough risk assessment of your accounts receivables portfolio at regular intervals - at least annually and then in the case of unusual market situations, for example, a pandemic - can save your business, in terms of both financial health and maintaining strong customer relationships.

There are seven core components to a risk assessment: 

  1. Conduct a customer credit assessment more than once. Typically this is part of the onboarding process with a customer - a credit assessment through which you evaluate the health and wellness of your customer’s business and financial situation so that you can determine the credit terms you will extend. But doing this at the outset of the relationship is only the first step. Conducting a regular review - at least annually - of your customers’ financial standing and creditworthiness protects your business and your relationship with your customer. It allows you to get ahead of any potential financial rifts they may be facing and preemptively negotiate changes that keep both parties happy. 
  2. Review your Aging Receivables report. This report shows you the unpaid customer invoices and unprocessed credit memos based on the number of days specific invoices are past due. It’s a simple way of tracking late invoices and determining how well your credit and collection functions are working. 

    If your report begins to reflect a deterioration trend, it may be time to investigate what’s causing late payments before your customer’s problems translate to a serious cash flow issue for your business. Maintaining regular contact with your customers and having a clear and documented collections process will help you to closely monitor such trends. In addition, it’s important to understand the difference between industry-standard payment practices and early warning signs that your customer is experiencing financial stress. Focusing on deviations from typical payment patterns is key.
  3. Define your process for handling a ‘deteriorating’ payment trend. You have a collections process that runs standard for every invoice, but how are you handling those customers who were steady until Covid-19 hit, and now are far behind? Depending on the customer, your established history and the perceived level of payment default risk, you could put a credit hold in place once the aging report has reached a certain threshold or have your internal collections team facilitate a call with the customer. If those steps don’t solve the problem, you will need an escalation plan that includes written notices and potentially legal action. The key for managing this is having consistent communications with your customers and a clear process for handling the change in their payment patterns that minimizes risk to your business and cash flow.
  4. Consider the costs to your business.  Part of your risk assessment strategy should include understanding the hidden costs associated with risk management. While the actual value of an overdue invoice is obvious, calculate the financial impact to your business for the soft costs, such as onboarding and training, legal fees and new software to aid in the collections process. If you have to scale up efforts in collecting against deteriorating payments, and potentially upgrade your credit assessment process up-front (before the customer is ever extended credit) these costs all impact your business and your bottom line.
  5. Understand your customers' industry. The more you know about your customers’ industry, the better you can shape your own credit-to-cash process to ensure success for you both.  For example, if your customers are in shipping, get to know their processes and freight costs. If they are in manufacturing, what is their production and inventory cycle? What are the regulatory and compliance considerations they must meet which may impact how they manage their business and their finances?  Your deeper understanding of their business practices and industry requirements means you can tailor your business to support their needs in a way that is still lucrative for you. And it builds trust with your customer as they know they are working with a partner who “gets” them and their business.

    This also can lead to a tighter customer relationship if you use the opportunity to spend time with your customer. Personal interaction can lead to an increased understanding of the corporate strategy and future outlook, and ultimately drive increased credit support. The development of personal relationships frequently creates higher comfort levels and trust with a customer’s management team and their ability to effectively manage liabilities. This approach also gives you a chance to watch out for some of the softer signs of impending financial trouble, such as questionable management decisions, high turnover among senior management and problems with succession.
  6. Improve the skills of your collections teams. Collections conversations are difficult on a good day. Ensuring your team has not only a documented and clear process to follow, but the training and support to manage their tasks and conversations in a positive and supportive manner, is key to maintaining strong customer loyalty. A team that is clear on their processes and decision-making latitude, that is empowered to act decisively, and that has proper skills training will be effective in ensuring your cash flow is steady and your customers are happy. 
  7. Plan for the unexpected. Yes, you could not have predicted a pandemic for March 2020. But you can put measures in place to support your business through unexpected circumstances and market conditions. Part of your risk assessment analysis should be your disaster recovery plan: how will you continue to support your customers in emergency situations? How will you collect payments? How will your business continue to operate? This is often overlooked in DR planning processes - companies are often focused on the physical operations and delivery of goods - but it is critical to understand how you will manage customer accounts, communication and the flow of money. Documenting and regularly reviewing a DR plan should be a key part of your annual risk assessment plan.

Risk assessment is not a one-time activity, nor a single-threaded one. Even when your focus is on accounts receivables, it requires the attention and collaboration of management and multiple departments to ensure you are effectively assessing your business risk, supporting your customer relationships and managing cash flow.