Customers are the lifeblood of any business. You wine and dine them, promise to be their partners, and shape your strategy around what they want. But these days, customers may be more like vampires if their own cash-flow woes hamper their ability to pay your bills.
With more and more small companies declaring bankruptcy — Chapter 11 filings were up nearly 70% year-over-year as of March — or simply closing up shop, more finance executives are taking a tougher stance on managing customer-credit risks. Or at least they’re trying to take a tougher stance.
Pam Krank, president of Credit Department, an accounts-receivable consulting and outsourcing firm, says CFOs are “finally putting credit risk at the top of their lists” for the first time in her 18-plus years in business — but execution, in many cases, is lacking.
“We still find that many companies are not looking outside traditional credit practices to proactively assess what their risks are,” says Krank. For example, some don’t analyze risk at all, but just “go through the motions” by ordering Dun & Bradstreet reports without truly reading them.
Others “are still analyzing risk maybe once a year, instead of stratifying their customers so they can monitor the high-risk ones monthly or even more often,” says Krank. “CFOs are often very surprised by what’s actually happening in their own companies.”
Still, the current economy is prodding many to latch on to what Krank would consider best practices. Kevin Amoth, CFO of privately held lumber wholesaler Silvaris Corp., wanted to minimize the surprises he faced from credit risk, considering that most of his 1,500 or so customers are wood-crate and pallet makers that get paid slowly themselves. To that end, he instituted a new credit policy in January: his staff must refresh the credit file for any returning customer that hasn’t ordered in the previous six months. “If they buy from us at least once a month, as many do, we can monitor payment history,” he says. Amoth’s staff does this in large part with the aid of a new automated alert system that flags customers that are more than five days beyond their normal payment date.
That credit-file refresh involves not only ordering a new Dun & Bradstreet report but also checking two or three trade references. “We have relied more on reference checking than anything else in the last six months,” says Amoth, “because we’ve found that credit quality is deteriorating faster than it can be updated in formal reports.”
Although the checking programs have been a relative success, they’ve come with some cost, says Amoth. With an estimated 40% of Silvaris’s 1,500 customers having some difficulty with cash-flows, his team has denied many of them credit and required others to pay off their outstanding balances before extending them additional credit. “That has caused some strain in the customer relationships,” he says, “but we’re holding the line on potential for credit loss.” He’s also been able to curb the size of his credit team, thanks to the automated red-flag tool.
Acting Like a Bank
Indeed, with many customers asking not only for credit but also for longer-than-normal terms, Krank recommends requiring them to apply for extended terms, rather than offering them for nothing. “We may ask for a personal guarantee or tax information,” among other pieces of information in the applications, she says. “If you’re going to extend these terms, you have to act like a bank.”
Getting more customer information can take a variety of forms, but many finance executives say face-to-face interaction — or at least voice-to-voice — is among the most critical. At Huntsman Corp., assistant treasurer Molly Pryor says the $10 billion chemical manufacturer has a longstanding practice of having her team carefully analyze customers’ financial statements. “When you do that kind of due diligence, you can be ahead of problems by six months,” she says.
Now, though, she’s spending more time getting the CFOs of customers with more than $500,000 in outstanding debt on the phone. “We have more active communication at more senior levels these days, where you really dig into what their projections are for their cash flow,” says Pryor.
Besides asking what expenses the company might be cutting, she wants to know about what sources of outside funding they might have. Those could include bank facilities that are close to maturity and might be at risk of not being renewed or renewable only at a higher interest rate (and expense). “If you’re an important supplier, they’ll work through it with you,” says Pryor. “Those that are really in trouble are evasive, and you typically can’t even get to the CFO because they’re on bigger matters with banks.”
To reduce the risk from customers on the verge of going under, earlier this year Huntsman formalized a policy of holding orders, according to Pryor. “If they don’t pay their bill on time, we don’t give them new product, and it didn’t matter if they were big, small, public, or private,” she says.
In cases where there’s a competitor to Huntsman, of course, that exposes the company to more competition. If Huntsman is the sole supplier, it risks putting its customer out of business. To mitigate those difficulties, Pryor says the company will offer to let select customers pay off their current balance on installment while requiring cash in advance or a letter of credit for any new orders.
Those measures seem to be working. So far, fewer than 20 of about 15,000 customers are on Pryor’s critical list, she says. In Huntsman’s latest 10-Q filed August 6, however, the company reported that allowance for doubtful accounts climbed from $47 million at the end of 2008 to $53 million as of June 30.
No matter how proactive companies become now, though, there’s still the past to deal with. For very delinquent accounts, Krank says she often tries to set up struggling customers on extended payment plans — as long as 18 months — that include interest and the right for a supplier to put liens on a customer’s property, thereby ensuring payment if the customer tries to sell the assets. “Most people in business really want to pay off their debt. If you’re willing to work with them, even paying it off over time, it really makes them feel good,” she says, “and you’re getting this steady cash flow” that can be as much as $1 million per month for some clients.
That method has an 84% success rate, she says, “and that way you preserve the relationship.”