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Insolvency is on the cards for those who can no longer pay their bills. To prevent this from happening in the first place, you should monitor your company's liquidity and manage it in a targeted manner. Andrea Kohrt, Senior Business Consultant Risk & Compliance at Dun & Bradstreet, explains in an interview how to ensure sufficient liquidity and the role a credit score plays in this.
Ms Kohrt, is there a rule of thumb for how companies can best ensure their liquidity?
Andrea Kohrt: Oh yes, there certainly is.
What is it? Would you like to share it with us?
Andrea Kohrt:I’d be happy to. One method is short payment terms for business partners and long payment terms for you. Specifically, this means that you should always try to negotiate the longest possible payment term when paying debts to suppliers, while making sure that the payment term is as short as possible for your receivables from clients and suppliers. This means that you have liquid funds again more quickly.
The liquidity of a company can be controlled in the short, medium and long term through targeted cash-flow planning. If I am being squeezed hard by my suppliers and have to pay a lot of invoices quickly, but cannot collect my receivables, then, in the worst-case scenario, I have a liquidity gap. This is exactly what we wish to avoid!
Thinking about the coronavirus pandemic, how can credit managers ensure the liquidity of their company?
Andrea Kohrt: Companies must expect that receivables from clients will be paid much later in uncertain times in particular and deal with a tense economic situation caused by crises such as the current coronavirus pandemic. That is why it is so important to keep a close eye on your clients and their payment behaviour. Monitoring ensures that you recognise early on if one of your business partners suddenly stops paying on time and you can take countermeasures at an early stage.
Overall Business Impact from Dun & Bradstreet also helps to measure the impact of the coronavirus pandemic on businesses. For example, the index rates a company's risk based on the extent of COVID-19 restrictions in place and also takes into account the risk to the industry in which the company operates. This means that reliable statements can be made about the economic development of companies worldwide during the coronavirus pandemic.
What should credit management staff do in the event of an unpunctual payment?
Andrea Kohrt: This is easy. They should start the dunning process straightaway! An efficient dunning system is particularly crucial when it comes to keeping my own liquidity at a good level.
You should be suspicious if you have clients who always pay on time but then suddenly stop. Why are they not paying punctually anymore? You should research how quickly the company pays its debts to other business partners. If the company pays others on time but not you, then your business partner may be using you as a source of financing or supplier credit.
If this is the case, you should carefully consider how important the business partner is for you and what the consequences will be for you if they do not pay. Depending on the outcome, you can then put measures in place at an early stage. This is how you can avoid liquidity gaps.
How can I use credit scores to ensure my liquidity?
Andrea Kohrt: The assessment of the creditworthiness of clients or suppliers should be based on valid data. Credit managers get an overall view of their clients by combining internal and external data. Based on this data, clients are categorised into risk classes according to a risk-based approach and targeted measures such as credit limit and payment terms are defined to manage risk and liquidity. This prevents risky new business from materialising without corresponding collateral.
The D&B Score from Dun & Bradstreet provides information on the likelihood of a company needing to file for insolvency in the next twelve months. The D&B Payment Index (Paydex) is one of the factors used to calculate the D&B Score, creating an accurate picture of the probability of default.
If, for example, the probability of default is particularly high, then you should only do business with the client for cash in advance. You should also always look at the payment history for additional information related to your decision. If, for example, the probability of default is low but payment behaviour is poor, then you can clarify the reasons for this – perhaps in a conversation with the client. There are companies that have a good credit rating but do not always pay immediately due to strategic liquidity management.
By monitoring the risk indicators, credit managers can react immediately to changes in credit score or payment behaviour and put countermeasures in place.
What influence does the credit score have on my Days Sales Outstanding (DSO) targets?
Andrea Kohrt: The credit score is a tool to decrease my DSO targets, i.e. the number of days that pass from the time the invoice is issued until payment is received in the bank account. I can use the score to control my payment targets and thus ensure my liquidity.
What does this actually mean in practice? What should a credit manager be aware of?
Andrea Kohrt: Credit managers get a 3600 view of their clients by including objective and valid external data such as the D&B indicators. You can react immediately to changes and ensure your liquidity with help from the daily monitoring of external indicators.
A rough rule of thumb is that clients who have a good credit score get a longer payment term. Clients who are in the red and have a high probability of default must be closely scrutinised. If you request payment in advance, you run the risk that your business partner will look for another supplier due to the payment conditions.
In these cases, it is the credit manager's task to determine which payment terms are still acceptable for which client based on the risk assessment and which are not, based on selected criteria. No general rules can be imposed in this case. This has to be decided on an individual basis from sector to sector and company to company. The credit manager’s task is to find the right balance between risk and opportunity.