Imagine one day picking up your local paper and finding that the front page story is about one of your largest customers filing bankruptcy. Overnight you go from a feeling of security and prosperity to one of fighting for survival.
This very scenario recently happened to a distributor when a large mechanical contractor declared bankruptcy and ceased operations. Besides the $120,000 in unsecured accounts receivable, the distributor found himself with a warehouse filled with inventory specifically stocked for this customer.
The situation is bleak. The contractor’s demise has resulted in the greatest crisis of the distributor’s history. But did the situation develop overnight? Let’s review what happened prior to the customer’s filing.
Ice in the Water
The sales guys were ecstatic, the mechanical contractor kept increasing his orders and never questioned or negotiated prices. Soon they had all his business, and at great margins. However, at the same time that sales were increasing, payments from the contractor were slowing. Small invoices were paid on time, but the contractor’s accounts payable department kept finding discrepancies on the larger invoices. On the distributor’s end the disputed invoices were tagged and not aged.
Because the large dollar disputed invoices never hit the 90 day bucket of the A/R Aging Report, management took it for granted that all was well. But like an iceberg in the fog, what they had was a disaster in the making. Oh, there were signs all right, they just didn’t look.
It was the company’s greed that got the best of them. They never questioned their windfall, nor did they think it strange that the customer didn’t ask for a better price. Had they made some calls, checked out the contractor, they would have found that he’d been cut off by all the other supply houses. They focused on volume and margin while ignoring the risk factors in extending credit.
Remember the “3P’s (Key Factors) in Credit Approval”:
- Profile:
- Who are you doing business with?
- How does the customer do business?
- Past Performance: Check ’em out. If they’ve never paid anyone in the past, chances are good you’re not going to be the first.
- Product Value:
- Demand – Maybe you’d consider selling dead or slow moving inventory to a less than ideal credit risk.
- Margin – Low margin sales require on time payment!
Hide It and It Won’t Hurt
Disputed invoices should never be tagged and not aged, just the opposite. A dispute means something went wrong, and if for no other reason than ensuring good customer service, management must know about disputes and their sources.
Had the distributor’s accounts receivable department been keeping a Systems Problem Log, the management team would have seen large dollar invoice after large dollar invoice out to the same customer. Had anyone tracked the source of the disputes, they would have soon caught on to the contractor’s game.
In for a Nickel, In for a Dime
Once the problem was finally recognized, the mechanical contractor’s management team suddenly became unavailable or were always out of town; working on a big deal, no doubt. When contacted, they were evasive and wouldn’t commit to paying. Yet, to maintain goodwill, the distributor continued to sell on credit terms. They didn’t want to jeopardize the business volume generated by the contractor, so they kept shipping and ordering inventory.
Think of the credit line assigned a customer not as a barrier to sales, but rather as a triggering mechanism for rechecking credit, and if the customer qualifies, bumping up the line. Like with a bad haircut, poor credit approval doesn’t get better with extending more, or with the haircut, cutting more.
The Future’s Bleak
The scramble is on at the distributor’s place of business. Loss of sales has created an excess capacity in people and equipment. The specifically ordered inventory must be liquidated at a substantial loss. The distributor’s trained and very loyal employees face downsizing. As to the $120,000 that’s due, well as an unsecured creditor the distributor may get a few cents on the dollar, in a year or two. And if the distributor isn’t careful, they could end up spending more in legal fees than they’ll ever get back.
The Lesson
The vast majority of past dues are good customers who will pay. In fact survey after survey has found that while on average 25% of accounts receivable are past due at any given time, less than 1% are ever written off as a loss.
The goal in collecting accounts receivable is twofold:
- Keep customers current and buying by early contact and finding out why they haven’t paid.
- Identify potential losses early on by early contact, finding out why they haven’t paid, and if necessary, turning off the credit spigot.
Yes, credit must be extended in order to do business in a competitive environment, but the game plan is to maximize sales while minimizing risks. This means knowing who you’re doing business with and how they’ve handled their credit with other suppliers.
A $120,000 sale with more on the way sounds great, but reads like hell on a bankruptcy notice.
…about Abe Sanchez
Abe WalkingBear Sanchez is founder and president of A/R Management Group, Inc., a consulting and training company specializing in credit and collections as a profit center. Abe started in the credit and collections field in 1967 as a repo-man with a finance company.
Developer of the copyrighted “Sanchez Profit Support System of Credit and Collection Management” and the “Sanchez Inverted Pyramid Past Due Model,” Abe has conducted training programs nationally for many corporations and associations. He has authored numerous articles on the topic of credit and collections and has been featured in several training videos. Abe can be reached through: A/R Management Group, Inc., P.O. Box 61, Trinidad, CO 81082. Telephone (719) 846-2661.