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I think Credit Today is fantastic. You cover many practical topics in the credit field that I use regularly. Just one recent example—a conversation on the ListServ about preferential payments—gave me tips that I used in an actual case. The specific information I picked up from this one discussion saved me $10,000, enough to cover my membership for many years!
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Improving Cash Flow in a Depressed Market
"We don't have receivables risk with the customer because they haven't picked up the product yet." That might sound like an ideal situation to most of us, but in this credit professional's industry it can be a major problem. We look at some specialized solutions to some very special credit and collection problems. When it comes to receivables and cash flow, Tosco Refining Company (Linden, NJ) faces three challenges:
- The petroleum industry has not seen much growth in recent times. "We're also currently in a depressed market," says Kevin G. Henry, CCE, Assistant Treasurer.
- The company sells "fixed price forward barrels" in the open market, which can add credit limit exposure. (The details of this will be discussed below.)
- While many of the larger players in the industry have the resources to provide large amounts of financing to their customers, Tosco (a smaller company) lacks these vast financing resources.
"All of these challenges lead to a need to make sure we have the best cash flow possible," explains Henry.
Tosco meets this challenge in two ways:
Receivables Overnight. "We work hard to make sure that the payment terms of our deals are being satisfied in a timely manner," says Henry. "For example, if we have five-day terms, we create systems to make sure we get paid in five days." This is particularly important, since a single payment can range from $1 to $10 million. If cash flow slows under these circumstances, the company may need to borrow from its bank line of credit, leading to additional interest payments.
Two of the most successful strategies in guaranteeing timely payment:
- Calling at least two days in advance to make sure the customer is going to send the money. "It makes more sense to call in advance to confirm payment than to say, 'Let's wait and see if it comes in on time,' and then maybe have to borrow if it doesn't."
- Utilizing EFT with its customers and confirming the wire transfer receipts.
The regularity of contact puts customers on notice that payments are expected in a timely manner." We don't allow as much float as do some companies that don't verify receivables," he explains. "We also know the chain of command. If we can't reach someone, or if we are not getting the answers we need from a certain person, we know whom to call in that customer organization for the information we need."
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Credit Limit Management. While most companies have the luxury of monitoring customer credit limits simply by determining the amount of current receivables they have outstanding, Tosco is faced with an additional challenge as a result of its program of selling fixed price forward barrels on the open market. For example, the company might sign a contract with a customer for 25,000 barrels at 50 cents a gallon for six months in the future:
- If in six months the price is 55 cents, but the customer is not in business and thus not able to meet its contractual obligations, it proves beneficial for Tosco, which can then sell the barrels on the open market at an additional nickel per gallon profit.
- If the price is 45 cents a gallon, and if the customer is not in business or otherwise unable to meet its contractual obligations, Tosco is in a situation of having to sell its barrels on the open market at a nickel per gallon loss.
To prevent this kind of problem, Tosco places some "market to market" language in its contracts with customers. It also assesses the "market to market" exposure with each customer every day. "We don't have a receivables risk with the customer, because they haven't picked up the product yet," explains Henry. "However, we do have a "market to market" exposure risk."
To assess each customer's credit limit, then, Tosco takes two things into account:
- The actual receivables risk (for the product the customer has already picked up).
- Market to market risk. "We identify how much forward business we have with each customer, how assured we are that the customer will be in business in the future to honor the contract, and what the price is each day."
Combined, this information gives Henry a more accurate assessment of each customer's credit limit than just using the actual receivables risk.
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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Outlook 2012
This month's survey explores...
- What the top problems are facing credit execs currently, and
- What the top improvement initiatives are.
Click here to participate!
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February 2012
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