Trade Credit in today's economy
11-06-2008
The entire economy is under severe stress. Confronted with this environment, receivables managers are increasingly pressured to ensure viability within their respective organizations.
WHAT YOU CAN DO TODAY
Make no mistake about it, in these difficult times the primary job of the person responsible for the administration of credit and collections is to ensure that funds are collected as close to the terms of the obligation as possible. There should never be any doubt as to why this task is critical to the well-being of your organization. Your customers have an obligation to pay within the terms of the agreement, and it's the job of the manager of customer receivables to make sure that this obligation is met.
The receivables manager is confronted with doing a fine balancing act between managing receivables while satisfying counter philosophies of increasing revenues in a down economy and becoming more restrictive in credit granting as a hedge against the rise in business failures. Needless to say, restricting credit to marginal customers is going to negatively impact revenues, while relaxing credit terms to marginal customers will have a positive impact on revenues but will negatively impact receivables turn and lead to an increase in bad debts. This situation presents a major challenge to the corporate credit department because today's credit professionals are burdened with the responsibility of maximizing revenues for their business unit while containing or minimizing losses.
Receivables management requires the ability to control the flow of inventory, determine what constitutes a worthy credit risk, and administer systems that streamline the order-to-cash process. In order to do these well, you must address the following areas: procedures for review and extension of credit, methods to automate, performance measurement, and an efficient reporting system. Focusing on best practices will help maximize profits and minimize losses.
Implement Procedures
You need to establish procedures for review and extension of credit to attain corporate sales objectives while at the same time limiting potential bad debts to a level within the constraints prescribed by corporate fiscal policy. This means a credit policy must be in place. The credit policy is governed largely by the objectives of the business. How best to accomplish these goals depends on the application of good business sense and a combination of factors peculiar to the business and its respective industry. You should consider the following points when establishing credit policy and procedures:
* Nature and size of the business,
* Overall company objectives,
* Classes of customers,
* Competitive conditions, and
* Current business conditions.
There are four basic types of credit policies.
Careful consideration of the advantages and disadvantages of each type of policy should help in choosing a good working credit policy for a particular business. Any policy must be somewhat flexible, but you should maintain a firm, businesslike attitude in the relationships with both the sales organization and customers. The terms of sale should be sound, practical, competitive, and clearly expressed, and the credit period should be clearly stated and adhered to as closely as possible.
Receivables managers who are most successful at maintaining equilibrium between ensuring receivables turn while maximizing revenue potential will likely maneuver their company into a very competitive position within its industry.
Automate
You'll want to adopt methods to vigilantly monitor each account within the receivables portfolio in order to identify those posing the greatest risk. Automation is the answer here. The rapid advance in risk-assessment software has resulted in sophisticated and affordable PC-- based software that screens entire customer portfolios in minutes and isolates those businesses that have the potential to fail. In the past, screening thousands of customers would have required a substantial number of analysts.
Establish Performance Measures
You should also adopt a set of performance measures that monitor compliance with the policies. By design, these measures should examine all aspects of the order-to-cash process to ensure maximum efficiency and turn of receivables dollars. Meaningful measures must do the following:
* Fill the need of a specific objective,
* Be compared to a standard or it has no meaning,
* Be consistent,
* Be used to take action,
* Provide a benefit, and
* Be communicated in association with the standard.
We should remember that what gets measured gets done. If a measure doesn't accomplish a purpose, don't use it. The measure should be designed to support the organizational goals. Standards should be established in accordance with past organizational or industry values and trends in order to facilitate internal month-to-month or year-to-year comparison or comparison to industry standards. In a tight economy, working-capital turn is a key component. Investors and lenders want companies with a good credit rating and conservative, liquid balance sheets. To see how you compare, you'll want to benchmark your business within its respective industry to ensure a sound competitive position. Measuring your position is only relevant if you're able to compare that measure to a baseline that tells you whether you are average, above, or below average in relation to others within your industry.
Some measures to consider when evaluating receivables performance include:
* Days' Sales Outstanding (DSO),
* Best Possible DSO (BPDSO),
* Average Days Delinquent (ADD),
* Collection Effectiveness Index (CEI),
* % Current,
* % over XX Days,
* Gross Bad Debt to Sales, and
* Active Customers per Credit Employee.
Communicate
Communication is the catalyst to creating efficiencies and productivity within the organization. It's important that receivables management keep sales and customers alike informed of changes in terms and the credit status of individual clients. The credit department is generally the first to know of a breakdown in the system as the customer often withholds payment because of shipping issues or product quality, etc. As these issues become apparent, it's essential that the problem be brought to the attention of the appropriate parties within the organization.
Efficient reporting systems ensure adequate communication in the organizational structure. The key word here is efficient. Many organizations overburden themselves with reporting to the point where it hampers operational initiatives. Reporting should be employed in a strategic manner to allow others within the organization-those who have a need to know-to learn what you're doing and how successful you are at doing it.
Before assembling a report, ask several questions:
* What is the purpose of the report?
* What should be the distribution?
* What is the frequency of the report?
* What will be the format of the report?
The sudden economic downturn will only accelerate the occurrence of major bankruptcies, so it's also imperative to have a general understanding of the intricacies involved in the bankruptcy process. This will ensure maximum return in what might otherwise be a devastating financial blow to your organization. To protect your organization's position in Chapter11 cases, a complete understanding of the automatic stay, reclamation process, defenses in preference proceedings, and claim-filing procedures is essential. There's also a need to understand appropriate protocol and fiduciary responsibility in the event the bankruptcy court appoints your organization to serve on a creditor's committee.
The pressures of today's uncertain economic situation coupled with the challenges of an ever-changing business environment dictate the need to embrace core business practices that ensure viability in managing the largest asset on the balance sheet of most American businesses today-- accounts receivable. The role of receivables management is critical in lending to the assurance of consistent revenue growth, maximization of cash flows, and increased profitability resulting from limited write-offs. Policies should complement the organizational mission. Measures should monitor compliance with the policies, and an effective reporting system should keep the organization informed of the role receivables management is playing and its impact on the business. An understanding of the laws that relate to bankruptcy and the extension of commercial credit also is essential. These strategies should keep your company growing strong in a weak economy.
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