Setting Up and Managing Marginal Accounts
The goal of any effective credit department is to find a way to make the sale. "There are other businesses out there that are willing to take your sale if you don't want to make it," observes Ronda J. Wilcox, assistant controller of Ferguson Enterprises Inc. (Knoxville, TN). "On the other hand, the credit department has an obligation to protect and control the risks associated with accounts receivable." In sum: While it makes sense to do business with some marginal accounts (as a way to grow your business), it is also important to set these accounts up in such a way that they pose the most potential for profit and the least potential for risk.
"It's important to be very careful when setting up marginal accounts," notes a credit manager for a Plainview, NY company. Research
When Wilcox conducts credit research on a new customer, she studies a number of credit tools in making her decision. Among the most important:
- Trade references. "The information you get from these references gives you a relatively good indication of the customer's payment history," she explains.
- Bank references. By establishing good relationships with bankers, you can often get a lot of worthwhile information on prospective customers. In most cases, Wilcox is able to get information related to: date the account was opened, average account balance, types of loans booked, payment history and balances on loans, and history of NSF checks.
- Financial statements or tax returns. When working with a corporation or other medium-sized or larger company, Wilcox will ask for copies of financial statements for the last three years. "This helps to establish trends in their financial strength," she explains.
If it is a small company (sole proprietorship) and/or new in business, it may not have financial statements. In this case, Wilcox will ask for copies of tax returns for the last three years. "Tax returns give you the legal name of the business, profit/loss information, and other important data," she explains. - Third-party credit reports. Depending on the type of business (corporation, partnership, sole proprietorship), Wilcox may seek business credit reports and/or personal credit reports.
Tracy L. Caliger, Credit Supervisor for HON Company (Muscatine, IA), also utilizes these basic credit research tools. In making her credit decision, though Caliger also considers another important dimension: Is the prospect who is applying for credit planning to do business with HON on a short-term or long-term basis? "We treat short-term orders differently than long-term business when making credit decisions," explains Caliger. Example: If a marginal customer plans to do business with HON on a long-term basis, Caliger might seek a security agreement up-front. "If we don't get a security agreement at the time of extending credit, and the customer later places a large order that requires a security agreement, we might not be able to respond to the customer's order in a timely manner, because of the time it would take to get the security agreement in place," she explains. To determine whether a new customer plans on doing business long-term or short-term with HON, Caliger contacts:
- The salesperson responsible for the account. "I want to know what kind of potential the salesperson thinks the customer represents," she explains.
- The customer's owner and/or CFO. "It might even warrant a visit to meet these people in person, discuss their long-term plans, and determine how we fit into those plans," she adds.
While the New York credit manager carefully reviews and analyzes the paperwork that customers submit (credit applications, financial statements, trade references, etc.) he takes his research a few steps further, in that he places more emphasis on third-party credit agency reports, personal contact with other credit managers he knows, and the salespeople than he does on the paperwork he receives from the customers themselves. The reasons? Customers tend to submit what is in their best interest to provide, including their best references, which won't always provide you with the most accurate picture of their payment habits.
- "Third-party reports are more objective than self-reported trade references," he states.
- He also places a lot of weight on what his colleagues in other companies tell him about the customer. "A customer's paperwork may look very good, but that isn't always the best indication of how he is going to pay you," he explains. "Talking with other credit managers who do business with the customer will give you a better indication."
- Finally, he relies heavily on the information salespeople provide. "Many times, salespeople have visited new customers several times before securing their first orders," he explains. "As such, they know a lot more about these companies than I do from just the paperwork. The salespeople know the principles, where they have come from, and what their reputations are in the industry."
When talking with salespeople, other credit managers, and other contact he has, he looks into:
- The integrity and background of the principles.
- The reputation of the customer in its industry (how well customers accept its products and/or services).
- The overall trend in the customer's industry (whether the industry is strong, growing strong, stable, weak, or weakening).
- The reason for the customer's decision to purchase from Veeco instead of another supplier.
Marginal Account Security
If it turns out that a new customer is, indeed, marginal, Wilcox considers a number of options in order to secure the account. "The dollar exposure of the new account will determine how much you need to control the risk," she explains. Among the most common tools she considers are:
- A deposit on the account.
- Personal guarantees (making sure the owners have sufficient assets in place to back up the guarantees).
- UCC-l filings on real property (land, personal property, equipment, inventory, accounts receivable, etc.).
- Letter of credit (from the customer's bank).
- Joint check agreement. "In such a case, I make sure the customer's check reads '[our company] and [our customer],' instead of 'or'," she emphasizes. "If it reads 'or,' our customer could cash the check without our signature."
- Credit card payments.
- Mechanics lien (if the sale pertains to the construction industry).
Caliger utilizes similar tools when setting up marginal accounts. As a former purchasing professional, she also emphasizes the importance of asking for only what you need from a customer. "Integrity is very important," she says. "When I was in purchasing, for example, I never called a supplier to ask for an expedited order unless it was absolutely necessary. When I did make such a call, the supplier always knew I really needed it and jumped through hoops to help. "The same is true in credit," she continues. "I never ask for anything from a customer that I don't really need when making a credit decision or when securing the account. I do my homework up front and decide ahead of time exactly what I really need from a customer before asking him to provide it." When the New York credit manager agrees to do business with what turns out to be a marginal account, he is very careful to make sure the customer fully understands the agreement. "Terms and conditions must be stated clearly," he emphasizes. He sends a detailed letter to the person who will be responsible for payments, outlining terms, conditions, and responsibilities. In some cases, if it does not seem prudent to extend traditional credit to a marginal customer, even after reviewing potential security tools, he may recommend a leasing arrangement. This not only protects his company's position, but frees up additional cash for the customer, which helps him remain financially strong. "We can offer longer terms and lower monthly payments, and the customer also benefits from tax advantages," he adds. Assertive Customers
If a marginal customer tries to "push the envelope" while talking with Caliger about credit opportunities, she utilizes another strategy she learned in purchasing: Regardless of how emotional or intimidating someone tries to be with her, whether it was a salesperson talking to her in her former purchasing capacity, or a potential customer talking to her as a credit professional, Caliger always brought and brings the conversation back to logic. Marginal Account Management
Once you set up a marginal account with the appropriate security features, monitors it on a regular basis. "You should also flag these accounts with certain restriction codes, so that any time they place an order, you are automatically notified," states Wilcox. "This allows you to make sure they're not going over their credit limit." Once a marginal account is set up at the New York company, the credit manager monitors it carefully. "If terms are net 30, I call the customer on the 31st day if we haven't received payment," he says. "I make sure they have received the invoice and that it is in order, and that the equipment is working properly. Then, I continue to call every day or two until payment is received."
If a customer is experiencing cash flow problems but expresses a willingness to work with the company, the credit manager will usually try to work out an appropriate payment plan. "If the customer does not work with us, of course, we end up
sending the account out for collection," he concludes. 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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