I just read a very good article by Frank Knight of Debtsource dealing with the potential pitfalls of so-called “COD accounts”. The article is reproduced below:

“I had to contain myself when the business owner told me that he wants to convert his entire company to a COD basis as he is sick of debtors that don’t pay. I wasn’t thinking of the loss of sales he’d experience as good clients who can get credit from his competitors won’t buy from him; or even thinking how he would convert his term customers to a COD basis; I was thinking what the business owner will do once he realises that he will have more credit risk in selling on a COD basis than on 30 day terms!

COD – or Cash On Delivery if you prefer – is an often overlooked section of the trade credit age analysis, mainly owing to the fact that the amounts relative to the balance of the book is pretty small. However, if companies were to calculate what their COD bad debt percentage is relative to the sales volume, it would not be surprising to note a bad debt percentage considerably in excess of a comparable figure on term accounts. But before discussing the reasons for this and possible remedies, it is important for the purpose of this article not to confuse COD accounts with genuine Cash transactions – where payment is received irrevocably in advance or on delivery via a bank transfer, guaranteed cheque or hard currency.

COD accounts are therefore defined as delivery against a negotiable payment instrument,  typically a cheque, which leads us to the first reason as to why COD sales are high-risk. Due to the perception that COD = Cash sale the task of administering the COD account is often left to sales or even the delivery personnel whom (with respect) know little of credit risk management. They collect practically no or minimal information about their prospective buyer and are only too happy to deliver goods against the collection of a cheque. Being a negotiable instrument a cheque can of course be returned for numerous reasons, the most common being insufficient funds; cheque alterations; payment stopped or effects not cleared. In such an instance the supplier quickly learns that they have in fact extended credit to a customer of whom they know practically nothing and with whom they do not have a standard terms and conditions of sale agreement, a scenario just perfect for the debtor who wants to dispute the payment or even worse – abscond.

Some companies attempt to protect themselves by printing terms and conditions of sale on the back of the delivery note or invoice, but unless this is signed by an authorised representative, which is hardly likely to be the person receiving the goods, this measure holds little water.

The first step in minimising risk on COD sales is for the creditor to realise that COD does not equal cash sales, but is indeed a form of credit. With most cheques cleared within 7 days in South Africa it is therefore not unfair to state that COD actually means 7 days credit, or at least 7 days from invoice. To be on the safe side the creditor should apply a 14 days rule. Once the supplier is comfortable with this mind-set the next logical step is to apply normal credit control procedures to what is now a credit account.

It is highly recommended that every new COD account applicant completes a COD account application form which incorporates standard terms and conditions of sale. Every account should be given its own account number so that levels of spend may be tracked, with a view to converting the account to a longer term (typically 30 days) account in order to “lock the client in”. After all, the very reason why companies offer credit terms is to generate sales, and what better place to start than regular sound COD customers.

In addition new COD account applicants should be credit checked. A cursory search including defaults, judgements, a bankers code and possibly a supplier survey usually suffices. This level of search is inexpensive and quickly highlights whether there is evidence of previous returned paper on bank records or whether the customer is unable to meet their commitments, thereby clearly increasing the risk of the COD transaction. Remember that it not unlikely that the very reason why the debtor is transacting on a COD basis is because of a problematical credit history, in which case no supplier will be anxious to extend 14 days credit.

Once the COD client has completed the form and been credit vetted (this process should take no longer than 24 hours) COD sales can merrily continue, with possible annual reviews to ensure no major credit history changes.

A further measure that may come as a surprise to some is to apply a credit limit to the COD customer, keeping in mind that this is essentially a 14 days from invoice account. In line with the more traditional credit limit on term debtors, the limit on a COD account should maximise the exposure at any time, thereby ensuring that large COD orders, or at least orders that exceed the COD limit are brought to the attention of the credit personnel, who are then in a position to make arrangements with bankers or credit check the account again.

For smaller over-the-counter cheque transactions it is not uncommon to insist on credit cards or cash, or use a cheque guarantee mechanism.

Credit management is ultimately designed to limit risk whilst maximising sales, and managing COD accounts as described above will do both – limiting risk by exercising greater control and maximising sales by offering good COD customers extended terms.”