Better Credit and Collection Performance at Less Cost

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"They manage themselves better than we could manage them," enthuses this CFO about his credit department staffers. How has that happened? It involved setting up an efficient, cost-effective credit and collection system, empowering the employees to use it, and giving them a stake in making it run right.

Editor's Note: This article originally appeared in the Credit & Collection Manager's Letter, which Credit Today purchased in 2006.

When Jerry M. Solomon joined Amsterdam Printing & Litho Corp. (Amsterdam, New York) as executive vice president and CFO in mid-1992, the company was struggling through a computer systems conversion. "We were sending out between 30,000 and 40,000 invoices a month and losing control of the data in the process of the systems conversion," he recalls.

Nor was research he conducted on bad debt data for the industry and for similar companies at all reassuring. "I found that we were clearly headed in the wrong direction," he says, "and that we had ample opportunity for improvement."

Something major had to be done, and Solomon's first two significant steps were to bring the credit and collections system under control and to hire Lance Bromley as corporate credit manager. "At that point," he says, "we started from scratch."

While the efforts and activities that have taken place since then are many and varied, they can conveniently be grouped into three categories:

1. Performance Measurement. "I strongly believe that you can't improve anything unless and until you can measure it," says Solomon. "Appropriate measurements allow you to plot a course and a strategy, and they allow you to actively involve the employees."

Over the course of about a year, Solomon and Bromley studied and tested several different measurements, looking for the ones that would most accurately reflect departmental performance in credit and collections. They ended up with two:

Twelve-month moving average DSO. To achieve this number, the department divides the average monthly accounts receivable balance for the prior 12-month period by the net sales during the same period and multiplies the result by 365. "Using a 12-month moving average allows us to level out the seasonal effects of our business," says Bromley. (The company does approximately 40 percent of its business in the third quarter.)
Year-to-date cost of credit and collection. This measure tracks cost performance in five areas, utilizing the year-to-date totals, and determines the percentage of total costs to net sales. Results are compared with prior year performance and budgets. The five areas are:
- Traditional expenses (labor, supplies, subscriptions, etc.)
- Collection letter costs
- Outsourcing collection fees
- Cost of money
- Bad debt

"We publish reports on these figures each month," says Bromley.

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2. Employee Empowerment. The next step was to help employees begin to take more responsibility for their performance, which involved three strategies:

Outsourcing. Solomon and Bromley reviewed all activity that took place in the department and targeted the non-value-added work to be outsourced. For example, they began outsourcing check posting to a third-party firm that had the employees and technology to perform this task most efficiently. "Now, the 300,000 checks we receive each year go to a lockbox, and the outsourcing firm posts them for us and feeds us the data electronically," says Solomon.
Technology. The two executives then sought ways to streamline the remaining value-added tasks with technology as much as possible. "We found ways to automate the simple credit decisions, leaving employees more time to concentrate on more complex decisions," says Bromley. "We also installed in-house computer technology to allow us to perform tele-collecting," adds Solomon. "By using different call patterns with the system, we've been able to improve our DSO."
Training. The third strategy involved improving the professional level of the employees via training programs and other external classes. "There are a lot of training and classroom certifications on the walls of our department, and the employees are proud of them," notes Solomon.

3. Incentive Program. Once measures were in place and employees were empowered, the next logical step was to implement an incentive program for them. Solomon and Bromley implemented the program in early 1994. Why such a long wait? There was a very good reason for it.

"Before I've ever introduced an incentive program at any company where I've worked, I always measured the process extensively to make sure that the program would not ultimately manipulate the employees or blindside the company," replies Solomon.

"One key to the success of any incentive program is employee buy-in," agrees Bromley. "They must understand and agree with the measurements before an incentive program will achieve the desired effect."

Experimenting
As mentioned in the first section ("Performance Measurement"), Solomon and Bromley spent about a year experimenting with and studying various measurements to find the ones that would best reflect actual employee performance, and thus be well suited to a successful incentive program. "We ended up throwing out a lot of measures that the employees didn't feel were fair measures of their performance," notes Bromley.

The incentive program is based on the second of the two measurements discussed above: the year-to-date Cost of Credit and Collection. Here's how it works: Let's say the company did $20 million in sales last year. (This is well under the company's actual sales, and is used only for illustrative purposes.) Let's also say that the cost of credit and collections was 5% of sales ($1 million).

This was the "benchmark" figure for the first year.

Now let's say that this year the company also does $20 million in sales, but that the cost of credit and collections is 4% ($800,000). This represents a $200,000 improvement.

The formula is set up so that the company keeps 80% of savings and employees receive 20%. Thus, the company would keep $160,000, and $40,000 would be divided up among the staff members.

The cost performance is calculated monthly. Each quarter, employees receive one half of their eligible quarterly bonus. The other half is placed in escrow in case performance slips later during the year. At the end of the year, the employees receive all of the remaining bonus money.

"By using a sales-to-cost ratio, we give employees an incentive to increase sales and to reduce credit and collection costs," explains Solomon. "As a result, we've found that they look for ways to approve sales. They use 'fiduciary judgment' every day."

Also, employees are not penalized if sales fluctuate, because the ratio remains the same.

Thirty Percent Bonus
How "real" is the incentive program? Last year employees received bonuses equivalent to about 30% of their annual base pay.

The net result of performance measurement, empowerment, and incentives is a group of employees who are much more motivated, much more committed to improvement (at both the personal and departmental level), and committed to operating with a healthy questioning attitude about the "status quo." "They're taking on much more responsibility for their work," says Solomon.

A walk through the department reveals "bonus charts" displayed in employee work areas predicting end-of-quarter bonuses. "The employees know what they have to do to succeed, and they concentrate on that work," says Solomon. For example, they spend most of their collection time with the largest customers. "They manage themselves better than we could," enthuses Solomon.

Adds Bromley, "This provides me with more time to manage other long-term projects and processes. I don't need to be as involved in the day-to-day work." And, not surprisingly, financial performance has improved in all areas of measurement. DSO has decreased a total of 11 days on the rolling 12-month average since 1993. Expenses have decreased in all five areas, many of them significantly. Outsourcing collection fees have even dropped, as employees take more initiative and responsibility for collecting in-house. Bad debt has been reduced almost 60%.

"To date," says Solomon, "the company has saved almost half a million dollars in credit and collections costs."

Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.