The management of accounts receivable of companies become ever more important against the backdrop of the current economic situation. It should be mandatory for a company to master systematic methodologies and tools of whole process management of the accounts receivable, from the time when the credit is established through the contract until the point of the actual collection of the debt, or the time when bad debt is affirmed.
Precautionary measures shall be taken before the actual trades take place, which include the credit investigation into the counterparty’s capability of honouring the debt, credit rating and the confirmation of credit quota, and the formulation of the contract terms, in particular, the performance and payment terms.
Credit investigation is a comprehensive judgment made before the trades on the operation conditions, business size and debt payment capability of the counterparty. The essential purpose of credit investigation is to understand the size of the trade, confirm the credit quota, develop proper payment methods and conditions, and to decide whether it is necessary to add the requirement for guarantees.
The credit rating given on the basis of the credit investigation serves to help the company determine the different controls measures against and credit quota offered to different clients. The credit rating is subject to adjustment over time in accordance with the annual or semi-annual credit reviews of the counterparty. The credit rating is an evaluation on both the financial rating (financial qualification) and credit worthiness (based on the payment records) of the company. The sales strategies and payment methods shall vary across different clients due to different ratings.
The formulation of proper contract terms is the last link of the precautionary measures and is the only legal ground that the company can rely on in its last remedies. The credit investigation and the credit rating should be taken into account when developing the contract, which should explicitly describe the rights and obligations of both parties, the payment methods and term, and the liabilities for breaches.
The company may request debt guarantee, cash and carry, or other assurances from the clients with low credit ratings, while offering higher credit quotas or even extension of payment term to clients with higher ratings. Alternative effective assurance in case the counterparty fails to repay the debt includes adding a retained ownership term in the contract.
Monitor during the trading
Even the best controls and management system will be destined to fail if not put in practice thoroughly. A real-time monitor of the counterparty’s credit and payment progress during the trading will minimize default risk.
The first step of real-time monitor is to identify who are in charge. The monitor responsibilities shall be assigned to the sales, financial and legal departments appropriately based on their functions. The management measures can only be implemented when there are cross-functional co-ordination, information sharing and consistent practices.
Another priority is the management of the contract and the monitoring of the performance of contract. The company shall watch over the performance and credit of the counterparty during the trading, and take immediate action and make records once any misconduct is spotted. The company shall also affirm and consolidate the evidence should there be any changes to the contract.
Meanwhile, the company should check whether the debt has reached the limit of the quota and closely follow the repayment, or increase of the due debt, so as to take responsive actions when necessary. Given that the vendors are required by the Contract Law and Civil Procedure Law to prove that they have performed the obligation of goods delivery in the case of any contract disputes, the company shall keep and maintain the original copies of the delivery notes, bills of lading, acceptance certificates, receipts and invoices, etc., or the copies, scans or photocopies of the same documents when the originals are not available for objective reasons. The maintenance of the performance evidence during the trading is a paramount task in the contract management and performance monitoring process.
The evidence should be stamped and signed by persons in charge. To check accounts with the counterparty regularly, and to extend the protection term and interrupt the limitation of action by issuing notice of payment in due course before the expiration of the limitation of action, are alternative management measures.
Responses after trading
This refers to the collection of overdue debt. According to the statistics of the International Association of Commercial Collectors Inc, only 58% of the debts overdue for over half a year are successfully recovered, and the success rate declines to 27% if the debts are overdue for more than a year. The figure is further down to 14% for debts overdue for more than two years. Thus, timely collection of debt is essential. The debts can be collected through lawsuits and non-lawsuit measures, the latter including collection by phone, letters, face-to-face visits, and non-official investigations accompanied by the major method of negotiations.
The lawsuit aimed at collecting debts distinguishes itself from ordinary lawsuits in the sense that the lawsuit is one of the methods of debt collection, instead of the purpose. In this light, common supporting measures are forcing the counterparty to the negotiation table, seeking preservation and detention of the assets of the debtors during the lawsuit.
In the case that the debtor refuses to co-operate, and the company fails to collect the money even through lawsuit, the company may need to apply for enforcement order to the court. The company may strive to solve the problem by seeking punishment measures against the dishonest persons, including blacklist and restriction of high consumption.
Li Weiming is a partner at Tiantai Law Firm
Tiantai Law Firm
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