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CEO quiz: What you should know about your largest asset

Abe WalkingBear Sanchezby Abe WalkingBear Sanchez

1) On average, what percent of business-to-business (B2B) trade sales involve credit terms?

2) In companies that sell their products or services based on payment at a later date, on average, Accounts Receivable makes up what percentage of their total assets?

3) In your company, where is the credit function located and who does it report to?

4) How do you measure the performance of your credit function?

5) What is the greatest source of return from the investment made in the credit function?

What About In Your Company?

1) 80% to 90% or more of B2B sales involve credit terms (payment at a later date) and, as commercial lenders have cut back on business lending, the use of trade credit has grown. In the U.S., as of Sept. 2009, the spread between business-to-business trade credit and commercial lending had grown by nearly $100 billion since the end of 2008.

In a recent online posting, Simon Groves, Experiential Marketing Manager at Atradius, wrote, "In tough times, the use of trade credit goes up and not down despite the fact that there's the additional risk of non-payment. A recent Atradius survey on the economic crisis, covering 3,500 companies in 20 countries, showed that in all but six of those countries the use of credit had risen during the economic downturn.

What's behind the rise in the use of credit as the medium for sales? There's probably an element of rejuvenating flagging markets, but in the main, it's to fill the gap left by the lack of bank lending available to buyers."

The Atradius Economic Crisis Report can be downloaded from www.atradius.com.It makes for interesting reading.

2) Accounts receivable (A/R) is one of, if not the largest, asset of a company selling on credit terms. On average, A/R represents 40% of total assets and, as more trade credit is extended, it can only increase in size. The A/R is also one of the most liquid assets of a business, being but one step removed from money in the bank.

Short term money due from customers, the A/R is far more than just an accounting transaction involving the billing of customers or a journal entry on the balance sheet; it represents the very reason why any business exists -- the profitable sale of goods and services. The management and the condition of A/R has a direct implication and effect on cash flow and on what is often the most profitable sales, that of repeat sales to established customers. Consider the cost difference between finding new customers to sell to and additional sales to existing credit customers. In a tight economy new customers are harder than ever to find, making existing customers ever more valuable.

Debits and credits are accounting terms used to record credit sales and payment on those sales but the creation of A/R and of its proper management are sales related.

3) In many companies, the credit and A/R Management function is still found in accounting and reports to the CFO or finance department. But the only reason the costs involved with trade credit are incurred is to acquire profitable sales that would otherwise be lost by having the ability to sell to customers who won't or can't pay at the time of purchase. Credit approval and the management of the resulting A/R is primarily a sales support function and, as such, should be located within or in close proximity to sales, but should not report to sales.

In the course of approving credit sales and then working with the issues involving past-due payments, the credit function interfaces with just about every facet of the business operation. It deals directly with customers (new and established), sales, billing, A/P, and other internal functions as well as with vendors and suppliers. It has access to information and insights that, if understood and used, can help direct marketing and sales efforts toward specific types of customers or markets. The credit function knows who is buying and paying.

Purchasing managers need to keep on top of changes affecting the supply of products and materials. Now, you may be thinking that sellers/suppliers extend credit to buyers and not the other way around and you'd be correct. But a supplier's credit worthiness or lack of it can adversely effect its downline customers. James Early of Marsh Trade Credit in Croydon, U.K. recently wrote, "One must understand the supply chain up the line also. An example (in the U.K.) would be the retailer Zavvi who failed at the end of last year as a direct result of the failure of Woolworths/EUK. Zavvi's main supplier was EUK and, when the Woolworths group failed, they suddenly found themselves in the position of having to pay the administrators for the stocks they already had on credit. Then they were unable to secure new supplies on credit terms of best selling titles in the Christmas market!"

The cost or loss resulting from a key supplier failing can also adversely effect its customers. The credit function can provide an initial and then ongoing investigation and review of key suppliers. And, of course, there is the cash flow resulting from the management of the A/R and its impact on purchasing being able to secure the best deal from suppliers by being able to meet or exceed their payment requirements.The credit function has a role to play in supporting the purchasing function.

The credit function can also support the operations function by identifying and reporting "areas of opportunity for improvement" throughout the entire business chain, thus bringing about new efficiencies that result in lower costs of doing business for everyone, including customers and suppliers.

It often seems as if the best input from participants at training programs and seminars comes during a break. So it was recently in Phoenix. The group was made up mostly of sales, operations and finance managers from the Floor Covering Industry. The program was on the copyrighted Profit System of B2B Credit and how it can best contribute to corporate profitability. During the lunch break, an operations manager based on the West Coast and working for an international company told how she had once been the credit manager, how in dealing with approving credit lines (never limits) and in dealing with past due issues (not collections) she found that she interfaced with customers, sales, finance, accounting, billing, the warehouse, transportation, vendors and other areas of the business internally and externally. From her position as the credit manager, she could identify inefficiencies that were driving up costs for the entire supply chain, including customers. She kept pointing out these areas in need of improvement, which led to her promotion to operations.

Credit Managers can directly contribute to new efficiencies throughout the entire business chain of suppliers, sellers and customers, if asked. The credit function can and should support more and larger new and repeat sales, customer service and retention levels, marketing, sales, purchasing and operations efforts, all while maintaining good cash flow and controlling bad debt.

Due to a lack of understanding on the part of CEOs and business owners, they don't ask more from their credit function, resulting in a missed profit opportunity. Most credit operations' ability to more fully contribute to profitability is not being utilized.

The accounting/finance function's responsibility is to safeguard assets and it must have oversight regarding the credit function as with all business functions. But the credit and A/R management function should report directly to the CEO or, in larger companies, to the operations area.

4) What is watched gets done. Days sales outstanding (DSO), the average time it takes credit customers to pay and percent bad debt are measurements of risks. If used to measure the performance of the credit and A/R management function, they will adversely impact profitability. The performance of the credit and A/R management function should be measured according to how it can best contribute to profitability, and risk management is but one factor in the profit equation and not the desired solution.

How hard is credit working to find ways to approve profitable sales while remaining confident of payment? What percent of the applied for dollars are approved? A good credit manager being measured and paid to focus on profit may well find ways to exceed the amount of credit applied for by customers while remaining confident of payment. A good credit manager properly trained and incentivised is worth three to four good salespeople.

Credit customers paying on their accounts, even if not current, most often keep buying. Good credit customers allowed to become and stay delinquent may take that next order elsewhere, resulting in a negative impact on cash flow, the loss of a repeat sale (often the most profitable sale), and a chance that the customer may be lost forever to their new supplier and friend.

Past due accounts not dealt with in a timely and positive way may also result in negative word of mouth advertising for, all too often, there are issues that must be resolved before a customer pays. The longer these issues go unidentified and unresolved the higher the cost of doing business for all involved.

Past due A/R management is not collections, the enforcement of payment. It is about completing the sale and keeping credit customers paying and buying.

The credit function should be trained on how to identify the different types of past due customers (every past due will be one of three types) and on how to use a sales approach to deal with the different types.

Past due A/R Management should be measured based on the percent of credit customers paying and BUYING. The incentive should be based on elevating profit levels and not on placing orders on credit holds/stops, on keeping good credit customers from buying. And, yes, there will be those credit customers, the smallest percentage, which represent a potential for loss (Type 2 financial serious and Type 3s). Potential bad debt can be identified early and controlled by having the credit function determine what type every past dues falls into.

When something goes wrong somewhere credit customers don't pay, and Murphy was an optimist (Murphy's Law). Fixing whatever went wrong, wherever it when wrong will contribute to improved cash flow, repeat sales, customer service/retention levels and, additionally, if these areas of opportunity for improvement are tracked and then communicated to the operations function, new levels of efficiencies and lower cost of doing business will result. Measure and pay for systems problems identified, fixed and reported.

5) The costs incurred/investment made in extending trade credit include a) additional administrative expenses, b) the cost of carrying A/R, the time and opportunity value of cash on hand, and c) bad debt losses from customers' failure to pay. So what is the greatest source of return from this investment in trade credit?

The most obvious answer would be more and larger profitable new and repeat sales while controlling losses. The less obvious answer is the support that the credit function can and should provide to customer service/retention, purchasing, marketing and sales efforts and to new levels of efficiency throughout the entire business chain of suppliers/customers/downline customers. Over the long term, it is this last contribution of the credit function that may prove the most valuable.

Not to discount the value of knowing of a failing supplier that may also spell your own failure or of larger new and repeat sales and good cash flow, but being able to identify areas of opportunities for improvement is like getting a good compounded interest rate. Not only does it drive down costs of doing business for your company, your customers and even your suppliers, it also creates an open environment where thinking about improvements is allowed, encouraged and rewarded.

In too many companies, credit management is still viewed and managed from an old and out of date risk perspective and is not being utilized to provide a competitive advantage. It is still often thought of as the ugly stepchild of accounting (as one CEO put it), as the place where sales go to die, as a cost center, a negative and, of course, as a necessary evil.

Credit and A/R management is about sales and much more.

An international speaker and trainer, WalkingBear is a founding member of PCCG (www.profitcreditgroup.com), an international group based on the Profit System. He has authored hundreds of business articles, is the author of Profit Centered Credit and Collections, co-author of STAFDA's Foundations of a Business, and co-author of the new international book, The Best Kept Profit Secret: The Executive's Guide to Transforming a Cost Center. He can be reached through A/R Management Group, Inc. at www.armg-usa.com.

COMMENTS: 1
improve the knowledge
Posted from: madhavi latha, 9/1/10 at 12:49 PM CDT
This is very useful to the students who are interested to do the activities in the college .

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