Credit mistakes startups must avoid or risk failure

Last week, Peter, a friend I met at an entrepreneurs seminar organised by Barclays Bank, shared with me how his business is on the brink of collapse due to bad debts. The trouble, he said, began immediately he started his supplies business three years ago.

Most of his competitors’ customers switched loyalty with very little persuasion. Little did he know that they came to him readily because of his willingness to sell on credit. In fact, as he later learnt, some of the clients he embraced were blacklisted by his competitors either because of late payment or exhibiting signs on financial distress.

Within few months, he ran out of money and had to borrow heavily to continue supplying and paying bills hoping that soon he would be paid and repay loans. Interest continued eating into his profit as cash flow often paralysed his operations before things went out of control last year.

To make the matter worse, he has no proper documents to take legal action against some of them as most deals were hurriedly made on a friendly note without written orders, signed delivery notes or any form of contract except word of mouth. This is a common problem affecting most entrepreneurs, especially startups without good credit policy.

Unless you are in retail business, most of your sales are likely to be made on credit. If left uncontrolled, debts or account receivables could be one of the most expensive elements of your business. If you have no credit arrangement with your suppliers, it practically means you borrow money to be paid with interest to supply your customers, who will pay you much later without interest. Worse still, you risk not being paid at all.

Most start-up entrepreneurs never give serious thought or consideration to the issue of debt collection until it becomes a monster and starts consuming them.

By then, they will probably have lost much in terms of high cost of financing, because they have to rely heavily on borrowing to stay afloat while chasing a difficult client for whom paying up is not a priority.

Experts agree that the process of managing account receivables is more than just calling customers to find out if the cheque is ready or when they will pay after delivery and invoicing. It is a rather technical process that should well thought out and documented before commencing trading.

Don’t be too desperate for a sale or eager to win a customer from your competitor. Establish a system of evaluating the financial history of a prospective client to better protect you from losing money on the back end.

Find out who else supplies them on credit and if necessary get recommendations from them. If the prospective customer has a bad credit history, don’t hesitate to demand full payment or let them know that you are not in a position to sell on credit. It is also important to set a credit limit for each customer depending on your own financial capabilities to reduce your exposure should payment delay or is not made.

Another common mistake I have found with most startups is extending credit facilities on friendly terms without proper documentation. This makes collection very hard and sometimes taking legal action difficult.

To safeguard your interest, it is always important to get all documents right from the start. Ensure there is a written contract and all orders are made on duly signed local purchase order before supplying.

Once you supply ensure they sign the delivery note and payment terms are clearly stipulated. These documents are very important should they refuse to pay and you have to involve debt collectors or take legal action.

Mr Kiunga is the author of ‘The Art of Entrepreneurship: Strategies to Succeed in a Competitive Market’. Email: [email protected].