Entrepreneurs take on new customers in the hope of making their business stronger and ultimately seeing them thrive. The opposite can also occur when acquiring new clients as certain customers weaken businesses by draining resources and profitability.

This stems from accepting clients based on sub-standard data, where the entrepreneur would be better off declining their business and fobbing them off on the opposition.

Frank Knight, CEO of Debtsource, a specialist in B2B credit management, said that in the context of growing global risks and the current economic climate, it was important to know your customer.

With the rise in interest rates, in South Africa and globally, the potential and actual trends in defaults are heightened, according to DebtSource statistics.

Businesses are more likely to go under in a high-interest-rate environment than they are in a low-interest-rate environment because of the higher cost of borrowing money.

“For instance, with high-interest rates, businesses tend to clamp down on spending. This has a knock-on effect, prompting economic slowdown and making it even harder for already-fragile businesses to repay debt,” said Knight.

“There’s a causal link between increasing interest rates and business default, and this is already being evidenced from the statistics of credit insurance companies in South Africa, as well as our own records on recoveries. Payment defaults that we are managing are starting to swell.”

Knight noted that many SMEs which had been borderline bad debt cases even before the increases, tended to tip over the edge as consumers grew more frugal and began to cut back on their spending.

In the case of larger businesses, their fate depends on how well they’re funded and whether they have strong enough balance sheet reserves to defend against tough times.

“Our records show that many larger companies that were once well positioned, by the time of Covid in early 2020 were beginning to publish financial statements showing inadequate reserves on their balance sheets,” he said.

“South Africa has seen several fairly sudden high-profile collapses of major corporates into business rescue. If that’s happening to big businesses, it presents a graphic illustration of what must be happening lower down the business pyramid to SMEs which at the best of times live from hand to mouth.”

Knight shared a four-point action plan of precautions that companies needed to adopt to protect themselves from the risk of acquiring bad customers which could negatively impact the growth of SMEs in this challenging business environment.

The first step is to formalise an appropriate contractual agreement with the clients. These terms will include consent; interest on overdue accounts; the ability to charge legal fees; a defined process of delivery taking place at the customer’s physical place of business and who's in control of the goods; insurance; and stipulation about what happens to prices in the event of exchange rate fluctuations.

“Secondly, when a new client is onboarded you've got to do a proper KYC (know your client) background check on that company to make sure that it is not involved in any fraud whatsoever – and that it is who it says it is. This check must include whether the company is creditworthy and whether it's an actual legitimate business opportunity for you to expand your own business,” said Knight.

His third tip for companies is to ensure they have a good due diligence process both at the time of taking on the customer and thereafter, to monitor them with regular assessments to keep abreast of exactly what's happening with that customer’s business.

“This includes checking whether it has had any adverse judgments or negative data at any records bureau; and being alert to any fraud indicators.”

“In approximately one in every 200 applications that we process, there's a fraud element to it. Some of these are companies set up fraudulently. They are not who you think you're dealing with, but they're trying to get credit specifically to then disappear without paying. Due diligence should include a look at who the directors are, the financial information and the age of the business; and obtaining bank and other supplier payment references.

“In our business, we do multi-bureaux monitoring, alongside our own information sources as well,” he said.

Fourth, notwithstanding regular monitoring, Knight recommends that companies perform annual reviews on clients’ businesses.

“Too often bad debts come not from the customer that applied for credit yesterday, but the one which first applied five years ago and whose business is now taking a turn for the worse. An assessment done on a company today may look very different from one five years ago, and in fact, any company’s profile can rapidly deteriorate.”

The average commercial account DebtSource was involved in was over R900 000 – amounts that rapidly added up, he said.

“Much of these background checks are common sense: ensuring it is not a tick-box exercise but involves some face time. We have individuals in each major centre dedicated to physical visits, on-demand knocking on doors, kicking tyres, and making sure a company is what it says it is and not simply an open field.

“From our experience, few companies have the resources to do all this themselves, especially compared to the potential cost of bad debts,” concluded Knight.

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