Time to Act
Charlie Goodrich

And welcome back.  Our October edition of Time to Act takes a look at company credit policies. 
Credit policies are not rocket science and are relatively easy to implement. But they are often neglected. Today I explain their significance and offer two suggestions for getting yours back on track. 


Charlie Goodrich

Founder and Principal

Goodrich & Associates

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October 2012 Vol. 1 No. 2
In this issue...
Who Gets - and Gives - The Credit?
Heard on the Street
About Us
Goodrich & Associates
[email protected]
Who Gets - and Gives - The Credit?
Credit decisions are important. And far-reaching - they can directly and quickly affect sales, profits, liquidity and return on investment. That is why credit policy, the means by which credit decisions are consistently made, is an often reached for tool in the turnaround toolbox.

And while credit policies are not rocket science and are relatively easy to implement, they are often neglected, ignored or entirely overridden, particularly by sales-oriented management or ownership.

The good news is that simple changes can quickly have a positive impact on the key metrics of your business, most important, cash flow.

Credit policies are important for several reasons...
  1. They are at the heart of your decision to move forward with customers. At its most fundamental, credit determines the ship/no ship decision and the sale/no sale decision. The policies you put in place - and how you choose to follow or not follow them - determine the starting (and ending) point of many deals.
  1. You want to make sure you get paid back. If you don't get paid back, you'll have no money with which to pay suppliers, employees or the bank. In certain businesses - restaurants, hospitals, nursing homes, just to name a few examples - this is a nontrivial risk.

    Imagine that you are a building materials distributor. If the contractor can't sell the house, there is no money to pay the suppliers (i.e. you). Guess what happens when real estate crashes.
  1. You need to strike a reasonable balance. If you insist on customers with pristine credit and/or if your payment terms are too onerous, you'll have few losses... but few customers as well.

    Most companies are in business to sell stuff, not look at it. So if you don't take at least some credit risk you won't be in business for long. The question, of course, is how much.
  1. Payments that take longer cause problems too. Longer terms often require higher credit limits to accommodate the sales volume. That means larger losses when the customer doesn't pay. Besides this default risk, there is the cost and consequence of tying up funds in accounts receivable as you wait for payment. Here as well, you'll have no funds for paying vendors, employees and others.

    The greater the days to pay, the more money invested in accounts receivables and consequently, the lower your return on investment.
So if credit policies are so important, how come so many businesses go astray? There are many possible reasons, but here are the most common:
  • The company doesn't have/adhere to a policy. Each customer is a one-off decision (often made on the spot by the owner or CEO).
  • The company uses easy credit as a crutch for ineffective sales.
  • The de facto credit manager is the sales manager (see previous point).
  • The company faces a liquidity crunch. In many situations, a sale today means an advance from the bank tomorrow with cash to pay yesterday's bills. Never mind that there is no profit on the sale (this hole only gets bigger).
  • The system is neglected. The market changes and terms are no longer competitive. The competition has either tightened or loosened terms and your business hasn't. More often, sales to specific customers increase over time, but the credit limit hasn't. Eventually, the system says don't ship even though shipments should be made and are made. The credit policy and the systems to implement the policy are now ignored and neglected.
So what's the solution? Lots of possible tweaks and considerations, but if you keep these two recommendations in mind you'll be in good shape:
  1. You need a credit policy and you need to maintain it.

    Do key credit parameters, total dollars outstanding, days to pay, make sense given the customer's purchase volume, competition and risk of non-payment?

    Let's look at my experience in the foodservice distribution business. The first time I walked through my client's door, accounts receivables totaled $45MM - all with restaurants, hospitals and nursing homes. The average customer took 45 days to pay and invoices 90 days past due or more were ballooning by $250K a week!

    What I found was a credit system that had worked at one time, but that had broken down with sales growth. Among other problems, the credit manager effectively reported to the so-called general manager, whose only direct reports were in sales.

    Long story short, we reconfigured and reinstituted the old and formerly effective credit system and brought the average days to pay down to 28 within 12 months, for almost $20MM in new found cash.
  1. You need clarity regarding who makes the credit decision and under what circumstances.

    Your credit policy needs to be specific and clear, allowing for automatic shipments when its parameters are met and no ship status when they are exceeded.

    Not to say that there aren't instances where overriding the policy is warranted. The key is in being explicit regarding the circumstances under which this can occur and the individuals who have the authority to do so.
Credit decisions - both good and bad - can have a broad and long term impact on the health and profitability of your business. The time to act in putting a policy into place is now... before you're faced with a decision in the heat of the moment or, even worse, a mess to be cleaned up after the fact.

Heard on the Street
This week, Carmen Reinhart and Kenneth Rogoff, two Harvard economists who wrote the book, This Time is Different, issued a short paper which shows that the US recovery from the current "Second Great Contraction" is better than other recoveries from similar US and worldwide contractions caused by systemic banking crises.

The paper is both short in length and short on heavy math and statistics, so it is readable. (Figure 1 on page 5 and Figure 3 on page 7 drive home the author's point if you want to skip the article entirely!)

Click here to read it.

About Us
Goodrich & Associates is a management consulting firm. We specialize in helping our business clients solve urgent financial problems. Our Founder and Principal, Charlie Goodrich, holds an MBA in Finance from the University of Chicago and a Bachelor's Degree in Economics from the University of Virginia, and has over 30 years experience in this area.

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