Part 1 of the interview with credit management expert Sunil de Silva appeared last week
Q: What is credit monitoring?
A: Credit monitoring is also a part of the credit management process. From the time credit is allowed to buyers, it should be closely monitored by the credit collection department. They can monitor every buyer to understand their repayment pattern.
If they observe unusual behaviour of a regular client, action must be taken without delay. For example, if a buyer with a very good repayment record delays payment or his cheques are getting returned, it should be considered as a ‘warning signal’.
Warning signals are very important in credit monitoring. If a client avoids telephone calls, if he avoids meeting you, and letters getting returned undelivered are such signals. Adverse market reports about your client, bankers resorting to legal action are considered other signals.
From the time a credit is granted and until that credit is recovered in full, the credit given must be monitored by the credit monitoring department.
Q: Who is responsible for credit management?
A: It is important to be very descriptive as to who is responsible in this exercise. Although the marketing team will try to achieve targets, it is up to the credit department to recover the money.
The bankers’ KYC (Know Your Customer) approach also applies to credit management. The companies should know to whom you are selling, their financial position, relationship with the bank, backgrounds, etc. If the company is not doing well, that information should be available to the seller.
A banker can analyse the financial statements before granting credit. But manufacturing or trading companies cannot do it. Therefore, KYC is important.
The entire credit department must be responsible in the recovery efforts and monitoring their performance is also an important factor.
In credit management, there should be a strong and effective credit collection mechanism and they should have the details of credit given to customers. Age analysis of all debts must be carried out. They should follow up with phone calls and then visit the customers to see what has gone wrong.
Q: What can we expect in turbulent times such as this?
A: In turbulent times, companies need to effectively manage cash flows. Today, sellers and buyers in Sri Lanka are facing problems. While facing difficulties in manufacturing or importing goods, the companies are unable to collect credit on the due dates.
Cheques given in settlement of credit are being returned unpaid. The collection department or debt collectors are unable to push buyers to pay back immediately. Unsold goods are held in their stores. Sometimes, companies threaten buyers with legal action.
But practically, taking legal action is of no use when the buyers are in financial difficulties. Finally, the firms might declare bankruptcy as there is no way out. There is a chain effect in all these happenings. When the economy is not doing well, no one can succeed.
When a company is unable to collect their debts, they cannot meet their dues on time. They cannot pay their suppliers, settle bank borrowings on time. The problem is not regional, seasonal or temporary. It’s escalating day by day.
Two years ago, the Central Bank of Sri Lanka offered a debt moratorium to borrowers as a relief measure. The banks and finance companies were asked not to recover loans or take drastic recovery action.
If you continue to borrow from banks, there will be a day when you can’t repay your lenders. The recovery team must somehow recover it. But if buyers don’t have a cash flow, avenues to recover are limited. Today, the police are also not very strict on returned cheques or complaints about defaults.
Commercial banks and other financial institutions can enforce collateral to recover their dues. But the trading companies cannot go that far.
Ordinary people have a real problem generating an income nowadays. Wage earners get a salary, but their buying power has deteriorated. Due to the depreciation of the rupee, the prices of all items will further increase. The public will resort to buying only the essential items, rather than luxury items. Companies selling luxury items will be affected and might soon go bankrupt.
With the Covid-19 pandemic, many companies faced difficulties, but in the post-Covid situation, people don’t have the buying power. This situation affects everyone and the entire economy.
The default of credit at this juncture cannot be described as willful default and it’s purely an unavoidable crisis.
Q: What happens when buyers are unable to repay loans?
A: When a company faces default in credit by buyers, the only remedy is resorting to legal action. This means the end of the relationship between the buyer and the seller. In a small market like Sri Lanka, buyers and sellers don’t have many options to move to other suppliers and buyers. This is true for many medium-level companies.
However, it is different for multinational companies who get a bank guarantee before supplying to buyers. If buyers default, companies can claim on the bank guarantee. But medium-sized companies cannot do this in the absence of any collateral.
Through experience, we know that if someone doesn’t pay their dues within 90 days, this means that chances are low that they will pay at all.
Companies need to consider giving longer credit periods to retailers as they can’t simply write off credit to those who default. It is also difficult to take all defaulters to court given the legal costs and time spent on the process. You may lose your customers and the goodwill after ‘killing’ your buyers.
Q: How can companies address this situation?
A: Other countries have debt insurance schemes where the insurance company pays the seller in case of default. In Sri Lanka, we must introduce credit insurance schemes to strengthen the economy. This is a good opening for insurance companies to have a debt repayment insurance cover after studying the process carefully.
Another way is to approach factoring companies that buy your trade credit at a discount.
Selling debtors’ books to factoring companies is a good option. This is available in developed companies and works well. The factoring company can also discount the Goods Received Note and pay the seller immediate cash.
Then it is up to the factoring company to collect it. You can leave the burden of recovery to another party. Factoring companies buy the debt and recover using their strong recovery teams.
Handing the recovery of credit to debt collectors is another option. However, solving issues through negotiations and agreeing to reasonable repayment arrangements, rescheduling debt are sensible solutions for a long lasting relationship and for a win-win situation for sellers and buyers.