Picking Up Warning Signs
Dan Morris compares the situation to a railroad crossing. "While the train may not be coming, you need to be cautious," advises the president of Morris Anderson Associates, Ltd. (Chicago). "That's because there's a difference between seeing a flashing light and seeing the train when it's almost on top of you. A crisis requires significantly different action than does a cautionary sign. The problem is that trade creditors often get information that's old and stale. Consequently, they may be behind the curve by 90 to 180 days." The solution, of course, is to be on top of the debtor's financial situation well in advance. "The process involves a progression of signals," he notes,"beginning with cautionary signs, evolving into warning signs, and ending in financial crisis. Creditors that are effective collectors when the first cautionary signs become apparent tend to recover substantially greater percentages of their accounts than they might otherwise.
"The information you want to put your hands on is not so much days sales outstanding as business plan details that tell you roughly what's going to take place at the debtor company. If a business or restructuring plan is available, then you can generally analyze and determine what their position is, and make intelligent judgments as to whether you should cut, compromise, or run." The Direct Approach
The best way to get such important information, Morris continues, is through the direct approach. "The only way creditors can be sure of the information they get is if they get certain key facts straight from the debtors. That information is usually forthcoming if the two have good communication throughout the collection process. But face-to-face meetings are best. You need to sit down with the company CFO and make it clear that you will need to see certain information if you are to continue doing business. But don't put the client on the defensive. Instead, offer your assurances that the information you see will be kept in confidence." Your specific needs will best indicate the type of information that will help you most. Morris cites payables aging, inventory levels, and cash flow as among the most helpful to most creditors. While some of these signs this data can reveal may be reliable indicators of a debtor cash shortage, they may be too little, too late. "When there are warning signs," he says, "it's often too late and the damage is done. Then, creditors have to either take what they can get, or hope they can get better terms through other channels." So when you see these signals, you have to act quickly, but don't shoot from the hip. "It's not always in the interest of creditors to insist on collecting their full balance," he suggests. "So the critical element is to determine whether the debtor has the wherewithal to satisfy a compromise. It's one thing to go into a collection proceeding where you give an hourly or flat fee to a collection agent. But when you're working with cash-poor debtors, it doesn't matter how hard you hammer them." The Time to Collect and Run
So the time to collect and run is when you determine that your debtors have the cash to pay. And you learn this by understanding their cash flow and business cycles, and knowing when they're cash fat or tight. "For example, if you're working with someone whose entire business depends on the Christmas season, you don't want to be too demanding when they're building up their inventory, because there's no cash. The time to be strong and demanding is when they're in their collection cycle, since that's when they have more cash."
Morris urges caution over special "lock box" arrangements. "Most debtor companies that are in trouble are financed by asset-based lenders, or are handled in work-out departments of financial institutions and are subject to lock-box arrangements on their receivables," he points out. "So their cash goes directly to the bank. But if the asset-based formulas remain in place, account debtors can borrow under those formulas and can pay trade vendors--or at least some of them, depending on who has the most clout or who makes the most noise." Personal judgment must also play a major role in a creditor's decision to work out terms, or get out quickly. "Another critical element is to know what the probability of getting more cash is if you stay in any longer," Morris suggests. "And that's often tempered by your ability to service the account on a C.O.D. basis for every piece of merchandise you sell. That's a consideration that's usually made by the marketing and sales department. But credit managers need to understand those things. It's been proved that creditors who continue to work with accounts, and who sell debtors in trouble by having them pay C.O.D., generally fare better over the long term than those who demand immediate payment; working with the debtor enables him to operate his business and maintain cash flow." Getting the Best Possible Deal
How can you be sure that you will get the best possible deal from your debtors. "The best way," says Morris, "is to encourage the debtor to form an informal trade vendors' committee that can negotiate on behalf of all vendors. Implicit in that process is the fact that all vendors will be treated alike and probably get better or more current information. Single-source suppliers can, of course, cut their own deals, but single-source suppliers are unusual. So it's generally in everyone's best interest to work with the other suppliers and negotiate with the debtor for everyone." Surprisingly, Morris contends, most creditors, as a group, fail to make individual arrangements. "Most creditors fail to make these arrangements because they assume everyone's cutting their own deals, and they're never sure they will get the best one. With a committee working outside of bankruptcy at the debtor's request--which can be arranged through an adviser or attorney without threatening bankruptcy--suppliers can usually cut the best deal for the group. But implicit in that arrangement is the understanding that the creditors will continue to support the debtor's operation. Obviously, if trade creditors all want to be paid without supporting the debtor's operation, the debtor will not be able to pay and will go out of business."
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.
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