How and when to refuse an order
Following the high-profile failures of Tree of Life and the Health store (an unfolding story close to my heart as their owners, Health Made Easy, bought Peppersmith from me four years ago), I wanted to share my thoughts on managing customer debt. Given what is going on with the economy, these insolvent wholesalers could be joined by other failed wholesalers, distributors and retailers.
The challenge is that nothing is more exciting for a startup and scaleup founder than an order. More than a dopamine hit, if your customers are B2B, these orders are often substantial and can make a tough week a great week. Large orders put you back on track and mean you can breathe easy again.
Hence as a founder, I know how hard it is to turn orders down. However, it is sometimes the right thing to do. Knowing when to say no, is essential to avoid defaults and then relying on administrators to pay you back. And please note that if you do end up dealing with administrators, if you do get anything, it is usually pennies for every pound owed. And even then, you will only see a payment after a long wait and after jumping through endless hoops.
How do I know this? I have been there. We have had wholesalers go bust on us, resulting in thousands of lost profits.
Of course, companies go bust all the time, and you should be prepared for it. For this reason, many businesses carry a provision for bad debts on their profit and loss account. This provision is a good practice, but you need not be passive and accepting of such a fate.
How to get in control
In my experience, these events are rarely a total surprise, and you often end up kicking yourself for not acting sooner.
To avoid bad debts and sleepless nights:
1) Set a credit limit for each customer. What level depends on the size, credibility and importance of the customer. It's down to risk. Work out how much you would be prepared to lose by doing business with that account. This amount will change over time, and credit limits can be extended as you build up trading history. You can also turn to agencies to help evaluate risk, but most of this homework can be done yourself.
2) Be strict on agreed payment terms. Those customers who have tight control of their finances, and hence are less likely to go pop, usually pay on time and in full and give you good reasons if they ever do not. Take late payments seriously. Be prepared to put the account on hold until they have caught back up and consider reducing their credit terms until they can convince you they are unlikely to default on future orders.
3) For some high-risk accounts, e.g. new businesses and export customers, Pro-forma terms (payment upfront) are standard practice. Of course, more customer-friendly terms can come later, but this is a sensible way to start.
4) Credit terms mean nothing without regular reviews of your debtor book. You and your accountant/finance team should regularly review your debtor list (weekly is normal). In this meeting, you should be able to flag any issues and decide if you need to take action, like putting customers on hold.
Beyond that, there are other things you can do.
1) Keep your ear close to the ground. Rumbles and grumbles can act as the canary in the mine. Talk to your network and trust your gut.
2) Check the trade press. For example, in July, The Grocer published an article about Health Made Easy needing to refinance. This article looked like there could be trouble brewing and should have caused suppliers to act more conservatively towards that account.
3) If in doubt, check companies house. Both Tree of Life and The Health Store were behind on their filing and had long overdue accounts. While there may be good reasons for this, it's nearly always a sign that financial plans have changed. Treat with caution
I hope that helps mitigate the risk of losses and ensure you can enjoy those dopamine hits without that nagging doubt spoiling the party.