Credit Management

Ways of Financing a Business


A business is financed in these ways:-


  1. Money invested by the owners – This may not be repaid but the owner expects a good return from the business – profits
  2. Money borrowed through goods taken on credit – This has to be repaid over a short period when the goods are sold
  3. Money borrowed from other people, ISALs, banks, MFIs injected into the business – this has to be repaid on agreed dates and with interest.      

e.g If business is financed through Money Borrowed or Money Borrowed through goods, there is need to have a good Credit management System. Credit Management is to plan the use and the repayment of the money.  Where goods are taken on credit, there is no immediate need to pay the cash back but payment of the cash will be required at a later date.  This is normally very short term 1 day, 7 days, 14 days, 21 days with a maximum of 30 days.  The same applies when a business borrows money, this money has to be invested into the business in order to generate enough money to repay the amount borrowed (principle) and the cost of borrowing (interest).  This is normally longer than credit and may be for a month up to 12 months depending on the agreed terms from the lender.

In simple terms credit management is the proper handling of credit given whether it is through the capital injected by owners, goods taken on credit or a loan from a third party.

  • Capital as Credit

Most people consider that the money that the owners invest in a business is not borrowed.  It is however in fact borrowed as the investors expect a return by way of profits.  Although there may not be a repayment plan that is in place, the owner expects the business to repay him through profit.

  • Goods taken on Credit

This is an arrangement in which a supplier or provider of a product or service provides it to the buyer without receiving payment and agrees that payment shall be done later within an agreed period under some agreed given terms and conditions.  Goods obtained by a business under such conditions may be slightly more expensive than goods paid for in cash as payment of cash normally comes with a cash discount.

A business may provide credit and receives credit.

Important factors to consider when buying on Credit:

  • Are Terms and conditions of the supplier favourable?
  • What is the cost of the credit?
  • Are the goods in high demand?
  • Does the business really require the credit?
  • How long is the credit and is it in line with your expected income from the sale?

Do not just take credit because it is being offered as some suppliers push their non-moving goods through the supply of credit.  Only take credit for goods that move fast.

 Important factors to consider when selling on credit:

  • Are the goods not moving fast on the shelves and are they perishable?
  • Are the goods too expensive that cash buyers will be fewer?
  • Are the customers trustworthy to sell on credit to?
  • Are the business cash flows robust to sell some goods on credit
  • Is the business getting credit on the goods itself?

For Credit to work for a business, it is important to ensure that when the goods that were bought on credit are sold, the funds generated is not used for any other purpose in the business but to repay the suppliers.

For example if Lobels supplies bread on 1 day credit make sure that this money is available the next day to pay and collect another load of bread.

Advantages of buying on credit:

  • The shop will be well stocked
  • Credit if well managed is a cheaper way of funding a business than borrowing cash
  • Once one supplier is happy with the way a business repays goods on credit, this will draw in other suppliers.
  • No immediate outlay of cash

Disadvantages of buying on credit:

  • Possible failure to sell the goods which will results in failure to repay
  • Suppliers may demand payment before the agreed date
  • If stocks do not move as per plan you may be forced to sell at a price lower than the cost price


Borrowing Cash

Most businesses grow due the ability to access cash from ISALs, MFIs, Banks and other people.  However it is very important that this step in taken only when the business person has identified how the funds are going to be used in the business at a profit.

The cost of borrowing is very important and a business should not fall into the pitfall of borrowing at a very heavy cost just because the money has been made available.  It is critical to assess the ability of the business to repay both the principle and interest of the money borrowed and other transaction costs like, security registration fees, administration fees, loan monitoring fees etc.

Factors to consider when deciding to borrow:

  • Is there well defined purpose/need for additional funds
  • How much is required and for how long?
  • Is there a clear source(s) of income to repay the loan?
  • Is the total cost of borrowing understood i.e. the interest cost, the administration costs, the cost to register security
  • Are the terms and conditions of the borrowing terms in line with the business operations?
  • What is the fall back position if the business cannot generate the loan repayment when it is due?
  • Are the loan repayment terms in line with the business income generation capacity?
  • What is the exact amount required? i.e. Don’t over borrow or borrow less than what is required?


Advantages of borrowing Cash:

  • It boosts capital base quickly
  • The business has the ability to grow as long as the cost of borrowing can be absorbed by the business.
  • Borrowing allows the business to spend money it does not have in advance.
  • The lender will instil some discipline on how the business is run as they may require monthly financial reports to be submitted.

Disadvantages of borrowing:

  • Potential to fail to pay back – if business fails to perform
  • Possible loss of property in the event of failure to repay if the loans is secured
  • Disintegration of groups/families
  • The cost of borrowing could be too high for the business and could strain the business operations


Why is credit/borrowing not always available?

Funds are not always available to businesses either credit on goods or direct borrowing from third parties due to the following:-

  • Poor supplier experiences with other businesses e.g poor repayments
  • Limited credit reference information
  • Bad record keeping
  • Lack of acceptable collateral
  • Perceived lack of experience of small business operators
  • Businesses run on an informal basis and not registered.
  • Migratory nature of how some business operate – move from place to place.
  • Unprofitable businesses

      How to improve the businesses chances of getting credit/loans:

      • Keeping up to date records of the business.
      • Running a business that is registered with Council.
      • Running a business from smart premises which indicate seriousness in running a business.
      • Ability to articulate the business strategy through a business plan.
      • Being a member of a business organisation
      • Opening a bank account and deposit business takings
      • Attending workshops on running a business offered by some organisations.
      • Before considering borrowing, seeking advisory services from MFIs, banks etc.

       Consequences of not paying back Loans/ Credit:

      • The business and the owners will be blacklisted if they borrow from registered financial institutions like MFIs or banks. This means that the customer will have difficulties in getting credit from any other organisations and this may even lead to not getting business licences if a credit check is done.
      • If security was put in place to support the loan, this can be lost.
      • The business may close as if creditors/loans are not paid on time, they will apply to court to get the business deemed insolvent.
      • Credit/Loans can be compared to a FIRE. If a fire is well managed, it brings comfort but if it is not well managed it can destroy anything in its pathway.
      • DON’T DEFAULT: it kills your reputation and your business and disappoints your customers as supplies will be cut.