Use Credit Holds to Better Manage Your Accounts Receivable
Control Your Exposure to Risky Accounts and Leverage the Payment of Past Due Balances with Credit Holds
Contacting customers to pay past due amounts (collecting) is an essential element of accounts receivable (AR) management. For most firms, late customer payments are a frequent occurrence and collecting them can be a difficult task. If collections are not done properly and in an adequate frequency, your AR will age, cash flow will decrease, and the risk of bad debt loss will increase. Collections also has to be done effectively with minimal alienation of customers.
We have written several articles on collections, which you can find in our archive. This post focuses on the aspect of collections that involves Credit Holds. A credit hold involves putting a stop on a customer order (holding it) until they pay the amount you require or otherwise take acceptable steps to pay what is owed. Removing a credit hold is referred to as releasing an order.
Holding orders has two major impacts:
Holds are a very effective escalation technique when previous collection efforts are not working
Holds limit your exposure to risky customers by reducing the amount owed by a slow-pay or no-pay customer.
While credit holds have their benefits, putting a stop on a customer’s order can pose serious risks as well. In this article we focus on the dynamics and potential outcomes of putting customers, and their orders, on credit hold. To learn more, you will need to be a paid subscriber.
Customers May View a Credit Hold as a Hostile Act
While holding orders is a strong action and can be very effective, it can prove damaging to the customer. Should a customer not have alternate sources of supply, an order put on credit hold can shut down their ability to fulfill orders to their customers, which:
Damages their reputation as a reliable supplier
Reduces their revenue and profit.
Although customers are not happy about being put on credit hold, doing so usually elicits a payment from them. It can, however, seriously damage a relationship with a customer, even though it accomplishes its main purpose — payment of a past due balance.
Even so, most customers understand why credit holds are used, and in fact usually use holds with their delinquent customers. Consequently, the costs and benefits of credit holds, as well as how to employ holds to minimize their negative effects will now be discussed.
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The Costs and Benefits of Credit Holds
There are generally three ways customers respond to an order (or orders) being placed on credit hold:
The customer may cease doing business with you and find another supplier, resulting in lost revenue and profit for you. It also reduces the time your company spends on collecting payment on their orders, which is probably multiple the amount spent on the invoices to prompt paying customers. Another benefit is that your overall AR portfolio credit risk is reduced.
The customer recognizes that you are serious about enforcing compliance with your credit policy and henceforth pays your invoices on time or nearly on time, to prevent their orders from being placed on hold. The customer may purchase smaller quantities, which might marginally reduce your annual revenue, but in return your cash flow benefits and your risk of bad debts is reduced.
The customer adopts this pay-with-order procedure for the future. It will probably reduce total sales to this customer over time, but will eliminate bad debt risk, cash flow delays, and administrative costs.
As you can see, the positive benefits outweigh any repercussions. Not taking advantage of credit holds will result in ballooning past due and an increased risk of bad debt losses.
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Getting the Most from Your Credit Holds
There are also several things you can do to make your credit hold policy more effective. The importance of the customer to your business will significantly inform what you should do:
Work with larger customers who are slow pay and high risk to try to establish how open credit terms can be used to your mutual advantage. The idea is to maximize revenue from these customers without taking on unnecessary risk. Therefore you need to explain to them that you will be using credit holds, as well as their credit limit, to mitigate the risk of bad debt. By discussing these issues up front, you should be able to establish a direct line of communication with them to address any issues related to credit holds that may result from your policies and their actions.
For mid-sized and small accounts with bad credit or a history of slow payments, don’t hesitate to implement credit holds when strict delinquency limitations are violated. The cash flow and bad debt benefits will usually outweigh the potential lost revenue. In addition, the administrative effort to enforce this policy will be minimal.
The other thing you can do with smaller accounts, should past due balances and credit holds become habitual, is move them to paying by credit card at the time of purchase. Even though you will incur an interchange fee, that cost is offset by getting your money within three days rather than the typical 30 days or more and eliminating bad debt risks. it also saves you from administering their credit holds.
In all these situations, the key to preventing negative consequences is to maintain open communications with your customers. If they understand your credit policies, and you immediately inform them when you are holding their orders, you will minimize any negative blowback. The key principal is to never let a customer be surprised that you have put them on credit hold.
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Final Considerations
The bottom line with credit holds is that they are a means of communication with your late paying customers. While credit holds provide you with a buffer against an increase in under-performing receivables, they also send a message to your customers that you are serious about enforcing your credit terms. In addition, credit holds are an effective tool for leveraging payments from your customers.
While some customers will react negatively to having orders placed on credit hold, most will understand that their failure to pay is the true cause of the hold. The bottom line: credit holds enable you to generate revenue and profit from customers that are a delinquency risk, whether that is due a financial weakness, or simply because they are an account that does everything possible to take advantage of the generosity of their vendors.