We started on delinquency levels in the last post.
https://faoblog.com/processes-ar-collections-delinquency/
Let us try to understand what really defines a delinquency level.
As articulated in the last post, delinquency is an amount which is overdue. To understand how your client may define the delinquency levels, we need to understand his business dynamics, his business model, competition, industry practices etc.
So if I have to bullet these, definition of delinquency levels will require a good understanding of:
- Defining the date when an amount will fall due
- We will need to understand what credit periods does the market offer
- What are the norms set by similar businesses for the credit period
- The market standing of your client’s customer
- If he is critical for your client’s sales, he will command a larger credit period
- The type of business will also define the length of the credit period – consumer durables will have a short period, whereas capital & engineering products will have a longer period
- Industry practices will also have a strong bearing.
- Defining tolerance limits
- After an amount becomes due, it is important to define thresholds for various follow up activities.
- The frequency and recurrence of default will have a strong influence on these tolerance limits
- The state of economy of that geographical region will surely be factored
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To my mind the approach of receivables is taken from the wrong angle. The decision to grant a credit-term is purely a financing decision. Companies are in the business to deliver products and services and not to finance the supply chain. This is where banks (should) have a role. We need to re-enforce the supply chain by optimizing the funding at the place where overall costs are lowest. It does not make sense for a AAA-rated company to push a long term on their suppliers with a lower rating. This will only result in additional costs in the supply chain. With this approach all sub-optimisation efforts in Accounts Receivables can be eliminated. Receivables can then focus on solving customer complaints and risk management.