The Receivables Challenge
What to do if customers are taking too long to pay their bills
When I acquired my business almost six years ago, the accounts receivable were running about 53 days. Within a year, under my brilliant management, that number was up to 60 days. Then we had a write-off of more than $100,000. As you can imagine, that caught my attention.
We had installed some pretty effective systems in other parts of the operation during that first year. The one area we'd neglected, however, was accounts receivable. And there were reasons for that. First of all, it was an area of management in which I had no experience. Second, my optimism and eagerness to grow the company led to my making some less than prudent decisions about extending credit. Finally, let's face it: dealing with receivables is not one of the more enjoyable aspects of running a company. In fact, it's downright distasteful.
Another obstacle is that the reports and management tools available to control receivables are pretty limited. At first I thought that the classic past-due report would be a great device to monitor problems. But upon scanning this monstrosity a few times, I found my eyes glazing over. I tuned out and we got into big trouble.
After that $100,000 write-off, however, we started a major overhaul of virtually everything we did. About two years later our receivables were down to the 40- to 42-day range, and lately we've even been in the high 30s. Bad-debt write-offs are running around $20,000 a year, or two-tenths of a percent of sales, compared with our past six-digit experience.
Here's what worked for us:
* Look at personnel. Often, I've found, the first step toward progress is to put someone different in a key position. That was true in this case. Our credit manager simply wasn't going to be up to the job once we revamped the system. We replaced him with a woman who had started out as our receptionist and had progressed through the organization. Although she didn't have any academic credentials or experience in receivables, she had a certain forcefulness and a personality that seemed just right. And it was. We also put her on an incentive plan -- she receives a cash payment of $20 to $100 each month based on the number of days of receivables. And she has been great at doggedly pursuing delinquent accounts and limiting our exposure to losses.
* Get yourself out. It finally became clear -- even to me -- that until I got out of the credit area on a day-to-day basis, we weren't going to make any progress. Owners are optimists. We're customer oriented. And both characteristics are lethal to the credit-approval process. Plus, if the customer knows that you can approve credit, you have no place to hide and are likely to acquiesce.
So we set the rules. I was no longer available for credit approval.
* Establish initial creditworthiness. There's an entire body of literature on how to establish the creditworthiness of a prospective customer, so I'm not going to repeat the material except to say: do it. Most companies understand that, but they fail to write up the necessary procedures and policies. We were no exception, but we are true believers now. Not only do we thoroughly spell out procedures, but we go to great lengths to communicate the logic behind the ground rules to our salespeople.
One technique we initiated helps keep both our sales- and credit people happy. Quite often, in order to lock in a new customer who needed a quick shipment, we'd bypass the initial credit check. While we couldn't continue doing that, we did install an interim "quick credit approval." A salesperson has to supply us with only a bank name and two vendor references, and we will guarantee a response within a half day for the first shipment -- with the understanding that the final full credit-approval document will follow. This procedure may sound trivial, but without it there was a tendency to use the rush situation as an excuse to forgo credit checks entirely.
* Check credit before shipment. Our basic computer system had some fairly good credit-checking capability at the time an order was entered -- in theory, at least. The problem was, we were partly on the system and partly doing the job manually. When we got the system entirely on line, we could implement the credit-checking features. Now, when an order is entered, the computer notes: 1) if there is a credit hold; 2) if a credit limit is being exceeded; and 3) if the customer is 60 days past due. If any of these situations exist, the credit manager has to clear the order.
We learned that if we didn't stop a risky account's product from getting out the door, we were constantly playing catch-up ball. And, frankly, our sales force -- maybe yours, too -- was not above trying to slip an order through the system.
* Monitor extended terms. Extending terms is just another form of price cutting. It also extends your receivables and your risk of loss. This was another area where I had to get out of the picture. Our controller has a good protective attitude about letting go of the money, and he now is in charge of approving any extended terms.
* Develop management reports. While I had to get out of the day-to-day handling of receivables, I did need overall management control. Gross measures, such as percent past due, are fine for estimating general progress, but they are not tools to help get at the heart of various problems. And with more than 3,000 customers, the classic past-due report by customer listing was a mind-boggling mass of data.
I finally developed a month-end exception reporting system that extracts the critical information that I need to oversee receivables (see "Hitting Your Numbers," April 1987). Briefly, this program isolates two groups of accounts. The first report lists only those customers whose accounts have undergone a statistically significant adverse change. Rarely is this more than 70 to 80 accounts out of 3,000, but they make up 99% of the short-term problems. The second report lists the accounts with a history of problems, which need to be monitored. Again, it extracts only about 100 customers out of 3,000, but covers 99% of the chronic offenders.
In both reports, since we display only a small fraction of the accounts, we can print out a six-month history, which aids immensely in tracking them. With these two reports, I have a firm handle on receivables within a half hour after getting the printouts. They're also a useful guide for the credit manager in pinpointing which accounts need following up.* * *
The payoff for all this effort has not been small potatoes. In my company, with $12 million in sales, the result of getting receivables down from 60 to 40 days is roughly $700,000. This may not be the most glamorous end of the business, but figures like that do quicken the pulse.
Charles J. Bodenstab is chief executive officer of Battery & Tire Warehouse Inc., in St. Paul. Previously, he held executive positions with United States Steel, General Cable, Kearney-National, and Gould.
How not to handle your receivables
Here's how I managed to wind up with a $100,000 receivables write-off. The technique is infallible, but I wouldn't recommend you try it.
* Start with an unknown individual who has a minimum of capital and a great story about his prospects in a far corner of the state.
* Offer extended terms so he can finance the inventory needed to generate the fantastic business he has described.
* When he is past due on his payments, rationalize that this is temporary, perhaps because of seasonality.
* Let the account's salesperson verify that the inventory is in fact in place.
* As you look at the financial statements, be sympathetic that this is a new operation having trouble getting a handle on its operating results.
* When you start to realize your customer is in trouble, don't take your losses early. Stick with him, and you ought to be able to double the amount you have to write off.
For selected industries*
Median number of days
Tires and tubes 42
Electronic-computing equipment 69
Employment agencies 41
Median number of days
Family clothing 8
*Fiscal year ends 6/30/87 through 3/31/88.
Adapted from Annual Statements Studies 1988 edition, with permission of Robert Morris Associates, Philadelphia