A Four-Phase Process for Assessing Credit Worthiness of Small Customers
"When I ask some of our customers if they have financial statements," says Larry Canada, CBF, CCE, National Credit Manager for GS Roofing Products Co. Inc. (Irving, TX), "I may get a response like, 'Well, I have about $400 in the bank, my wife says about $6,000 is owed to me, and I think most of our bills our paid because my wife writes the checks.' How are you going to do a professional analysis on that?" For this reason, Canada, whose company sells products to roofers, and who, in his previous position as a credit manager for a steel company, sold products to small machine shops, has had to create some alternatives to traditional financial statement analysis when assessing credit worthiness.
What he has come up with is a four-phase process that has helped his company remain about 96% current on receivables! Phase One--Assess credit worthiness. When Canada receives a credit application from a new customer, whether the customer is requesting a $5,000 line of credit or a line in the millions, he checks trade references and bank references. Since it is unrealistic to believe that a customer would provide a poor reference, Canada supplements this data with information he gathers from the territory manager. While he can rarely get audited financial statements, or even "official looking" financial statements of any kind, he still contacts the customer to get as much financial information as he can. What is critical at this point is studying the numbers he receives to make sure they seem realistic and make sense. It is only through diligence, patience, and perceptiveness that he can ultimately make an informed decision. For example, a new customer recently sent Canada an unaudited financial statement. Among the information presented was
- In business for 15 years.
- Anticipated sales of $250,000 this year.
- Sales of $247,000 last year.
- Receivables of $193,000.
These numbers alone raised a red flag for Canada. "How can a 15-year old company have sales of $247,000 and receivables of $193,000?" he wondered. He asked the customer what kind of terms he was giving his customers. The customer replied "30 to 60 days." Canada obviously challenged this, pointing out that it meant he was only turning his receivables just slightly more than once a year!At this point, the customer hesitated. "I must have given you a wrong number," he said. "My sales were higher." "Then give me your revised sales figures," challenged Canada. After the customer gave him a new number, Canada asked him for his revised cost-of-goods figure. "That stayed the same," replied the customer. This, or course, immediately raised another red flag, because Canada was quickly able to compute that the customer's claimed cost-of-goods figure was only about 10% of his claimed total sales figure! Now Canada knew the customer was being dishonest. "He had an income statement that was probably accurate, but he created his own balance sheet to make it look better than it really was," he says. "The two just didn't match." Phase Two. Once Canada has sufficient information from a new customer and has begun to develop some level of trust, he will usually extend a small line of credit to get the customer started. Phase Three. While many credit executives overlook this point completely, or just give it short shrift, Canada places a great deal of emphasis on it: "Explain your terms and conditions to the customer, and emphasize that you expect him to hold to those," he says. Only when customers know that they will actually be expected to comply with all terms and conditions as a matter of course will they consider prompt payment to be as serious a matter as it really is. Phase Four. Finally, Canada also has a very active and aggressive policy of visiting customers in the field, particularly new customers, whom he visits within six months of extending them credit. During these visits, he gets to know the key people and learns as much as he can about the company. With this information, he can revise his initial credit lines up or down, as their circumstances change. 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.
| 
Webinars
