Essentials of Credit, Collections, and Accounts Receivable PDF
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Rizal Technological University
2002
Mary S. Schaeffer
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Essentials of Credit, Collections, and Accounts Receivable, by Mary S. Schaeffer (2002). This book provides a practical guide for credit and collection professionals on areas such as credit approval, billing, collections, handling deductions, and customer relations. The book covers various aspects and approaches for different companies and industries.
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ESSENTIALS Y FL of Credit, Collections, AM and Accounts Receivable TE Team-Fly® Essentials Series The Essentials Series was created for busy business advisory and cor- porate professionals.The books in this series were designed so that these busy professiona...
ESSENTIALS Y FL of Credit, Collections, AM and Accounts Receivable TE Team-Fly® Essentials Series The Essentials Series was created for busy business advisory and cor- porate professionals.The books in this series were designed so that these busy professionals can quickly acquire knowledge and skills in core business areas. Each book provides need-to-have fundamentals for those profes- sionals who must: Get up to speed quickly, because they have been promoted to a new position or have broadened their responsibility scope Manage a new functional area Brush up on new developments in their area of responsibility Add more value to their company or clients Other books in this series include: Essentials of Accounts Payable, by Mary S. Schaeffer Essentials of Capacity Management, by Reginald Tomas Yu-Lee Essentials of CRM: A Guide to Customer Relationship Management, by Bryan Bergeron Essentials of Intellectual Property, by Alexander I. Poltorak and Paul J. Lerner Essentials of Trademarks and Unfair Competition, by Dana Shilling Essentials of Corporate Performance Measurement, by George T. Friedlob, Lydia L.F. Schleifer and Franklin J. Plewa, Jr. For more information on any of the above titles, please visit www.wiley.com. ESSENTIALS of Credit, Collections, and Accounts Receivable Mary S. Schaeffer This book is printed on acid-free paper. ∞ Copyright © 2002 by Mary S. Schaeffer and the Institute of Management and Administration. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, e-mail: [email protected]. Limit of Liability/Disclaimer of Warranty:While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies con- tained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. Library of Congress Cataloging-in-Publication Data Schaeffer, Mary S. Essentials of credit, collections, and accounts receivable / Mary S. Schaeffer. p. cm. ISBN 0-471-22074-4 (pbk : alk. paper) 1. Credit—Management. I. Title. HG3751.S334 2002 658.8’8—dc21 2002005070 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1 For my princess, Larissa Mary Noelle Ludwig, my wonderful, beautiful, gifted daughter Contents 1 The First Step: Approving the Credit 1 2 The Second Step: Billing 29 3 The Third Step: Collecting the Money 49 4 Accounts Receivable Issues 81 5 Handling Deduction Issues 103 6 Interacting with Sales and Marketing 115 7 Customer Relations and Customer Visits 133 8 Letters of Credit and Other Security Interests 147 9 Legal Considerations Surrounding Credit 163 10 Bankruptcy 183 11 Technology in the Credit and Collections Department 215 12 Professionalism and the Future of the Credit Profession 241 Index 253 vii Preface redit is part science, part art, and part gut-feel. The trick is to get C the right mix.While there is no one absolute right way to handle the credit, collections, and accounts receivable functions, there are a few that are totally and irrefutably wrong. It is the mission of this book to identify both for the reader. For the last eight plus years, I have been lucky enough to spend my days talking to credit professionals and writing about their successes and achievements, their trials and tribulations, and occasionally their catas- trophes as a newsletter editor for IOMA’s Report on Managing Credit Receivables and Collections. Much of what they have told me is reflect- ed in this book. Thus, the suggestions and recommendations are not pie-in-the-sky advice but rather practical guidance based on real life accomplishments and failures. Before reviewing what is covered in the book, I’d like to point out that there are many ways these functions can be handled. Often what works at one company will not at the next. This can be because the second company doesn’t have the technology of the first, and because the corporate culture is very different or can be simply due to differing industry requirements.Thus, many of the topics in the Tips & Techniques will cover a variety of approaches—some applicable to more sophisticated companies and some to the less advanced. The book starts with a look at approving credit.This should be the first step for companies before they begin a relationship with a new customer —although as many reading this are only too well aware, it occasionally ix Preface occurs after the fact, after the salesperson has taken the order. Chapter 1 begins with an explanation of why business credit is so important, verifies that a business does exist, and examines financial statements in detail. The chapter takes a look at the way companies evaluate credit, the information many require on their credit applications, and the references many require. Ratio analysis, how companies evaluate new customers, and what docu- mentation should be in the credit file are also examined. Many companies overlook the importance of their billing practices in the credit and collection process. An invoice mailed late will get a payment posted even later. Chapter 2 takes an in-depth look at invoices, the best way to design an invoice and best billing practices. An outsider might not realize that there are many things companies can and should do to their invoices to improve their ability to collect in the most timely and efficient manner and ultimately the company’s bottom line. Electronic invoicing is one of the hottest topics in the credit arena today. Chapter 2 takes a look at the practice and also offers details about five of the products on the market today. Electronic invoicing is likely to have a big impact on business in the next few years, and thus it is imperative that credit and collection professionals learn everything they can about it. The book then goes on to take a look at the thankless task of col- lecting. Many in the collection profession feel that at best they break even. If they do a good job, no one notices, but the moment collections slip, management is watching them like a hawk and complaining. Unfor- tunately, many who have this complaint are quite accurate. Chapter 3 contains numerous tips that have worked for professionals in the field today. We look at both the old-fashioned letter writing and the more current practices of phoning, e-mailing, faxing, and whatever else inno- vative collection professionals can dream up to get the money in the bank for their companies. x Preface Applying cash is another thankless job in corporate America today. However, if the task is not handled correctly it causes problems for other professionals in the company and, in some extreme cases, can tarnish the company’s reputation with prized customers. Chapter 4 looks at some effective accounts receivable strategies along with a discussion of the vaunted days sales outstanding (DSO) figures that so many credit and collection professionals are measured against. Unauthorized deductions, along with unearned discounts, cause Y credit professionals in certain industries (mainly those selling to retailers) FL more headaches than almost anything else. Chapter 5 examines strategies companies can use to minimize this haunting problem. The chapter also AM takes a look at techniques to use for timely dispute resolution as a few customers will use a small dispute (some say, imagined) to avoid paying large invoices. TE A smooth relationship with sales and marketing can make a big dif- ference in the amount of Tylenol a credit professional must buy each year. Some lucky credit professionals have wonderful dealings with their sales force. Chapter 6 discusses the strategies used to either maintain or initiate a warm relationship with sales. Also included are some things the credit department can do to make the sales force’s job just a little bit easier. Yes, you read that right—if credit goes out of its way to help sales, it will reap the rewards. Most credit professionals insist that customer visits are key to completely and accurately evaluating a customer’s financial viability. Unfortunately, some management don’t agree. This is unfortunate because when a customer gets into financial difficulty and has a limited amount of money to pay suppliers, after paying key suppliers, it is most likely to pay those it has the best relationship with—and inevitably, those are the ones where personal contact has been made with the credit professional. Chapter 7 looks at the best ways to plan and structure xi Team-Fly® Preface a customer visit along with some ways credit pros can squeeze in customer visits so even the stingiest of bosses can’t complain. Inevitably, the sales department will eventually (or perhaps imme- diately) find a potential customer who does not meet the company’s credit standards for open account terms. When this happens, the savvy credit pro finds a way to make the sale happen—usually by getting some sort of security. Chapter 8 examines some of the techniques that credit professionals can recommend in order to make the sale happen. Some professionals think that credit professionals really need to be lawyers first. There are a number of laws that credit professionals must know about and avoid breaking as part of their job. Chapter 9 takes a look at some of the legal considerations surrounding credit and collec- tion activity. Perhaps one of the most fascinating aspects of credit is bankruptcy. It is a regular part of most credit managers’ jobs no matter how good they are. Chapter 10 describes the different types of bankruptcies, the rights of creditors, and what creditors should do to secure their posi- tions. It also takes a look at what some consider one of the nastiest aspects of bankruptcy—preferences. A preferential situation arises when all creditors in the same class are not treated the same. If one or more has received a payment that the courts deem to be preferential, they are ordered to return it to the bankrupt company’s estate. This chapter dis- cusses some of the ways that a creditor hit with a preference claim can fight that claim. Without a doubt, the credit profession has changed more in the last ten years than it did in the previous 20. Many of these changes can be attributed to technology and the things that credit professionals can do as a result of the introduction of many technological advances. Chapter 11 takes an in-depth look at technology currently in use in today’s leading- edge credit departments. xii Preface The credit profession has undergone revolution. This roller coaster change is only at the first curve. The skill set required of the credit pro- fessional in the coming years continues to expand. Chapter 12 takes a look at a number of resources credit, collection, and accounts receivable professionals can use in the upcoming years to keep themselves in the credit game. Those who sit still will not succeed, but you’ve already taken the first step by purchasing this book. Good luck—it will be an exciting adventure for those who choose to participate. xiii Acknowledgments hroughout this book you will see mention of a company called T IOMA (Institute of Management and Administration), a New York City-based newsletter publisher. IOMA is the company I work for and the publisher of, among many others, a monthly newsletter called IOMA’s Report on Managing Credit, Receivables & Collections. In my posi- tion as editor of this publication since 1994, I have had the opportunity to interact with hundreds of credit and collections professionals and the vendors who provide services to the credit community. It is from these discussions that I am able to develop new material—not only for the newsletter each month, but also for this book. Additional material for my publications comes from the original research conducted by IOMA in the form of an annual survey where credit professionals from around the country share information about what they are doing, what technology they are using, and how they are evaluating their current and potential customers. Also, material presented at credit-specific conferences is helpful in breaking new trends. Without the backing of IOMA, this information would not be as readily available. In its ongoing commitment to provide the best infor- mation possible to the business community, IOMA also makes trial subscriptions to its newsletters available to those who request them either by calling its customer service department at (212) 244-0360 or through its Web site at www.ioma.com. A special thanks must go to both Perry Patterson, the company’s vice president and publisher, and David Foster, IOMA’s president, for making all this happen. xv CHAPTER 1 The First Step: Approving the Credit After reading this chapter you will be able to Understand the importance of accurately evaluating credit Evaluate the creditworthiness of customers Understand the different types of financial statements Identify the warning signs of customers in trouble here is an old adage in credit that says a sale is not a sale until the T invoice is paid. Until that point, it is a gift. It is the primary respon- sibility of the credit department to make sure that the company converts all those gifts into sales. It is also the job of the credit depart- ment to make sure that sales are made to companies that have both the ability and the willingness to pay for the goods. Why Business Credit Is Impor tant Finding the right credit policy is a mixture of art and science. Many issues affect the policy. Corporate culture, the company’s margins, com- petition, existing inventory, and seasonality are just a few of the matters to be considered, in addition to the obvious financial analysis. When credit is extended to a company that cannot or will not pay, the impact directly impacts the seller’s bottom line. More insidious, when the seller pays late, there is a bottom line impact as well, although it is not as 1 ESSENTIALS of Credit, Collections, and Accounts Receivable apparent. Similarly, when a buyer takes unauthorized deductions the action impacts the bottom line—sometimes to the point of making the sale unprofitable. Let’s look at a simple example. Here are the facts: Company A sells company B $1,000 worth of widgets. The company has a 5% margin. Company A is paying 6% interest on its bank loans. Payment is expected in 30 days. Company B pays the invoice 60 days late. Company B takes a deduction for $45 for a variety of minor issues. There should be a $50 profit on the sale ($1,000 x.05). In a 6% interest rate environment, the 60-day late payment results in an extra payment to the bank of $10 ($1,000 x.06/12 x 60/360). In this case, however, there is a loss of $5 on the sale ($50 – $10 – $45). Yet, few within the company would realize there had been a loss and sales would continue in this pattern. Now, many reading this may be thinking that deductions of this magnitude do not occur; let me assure you that in many industries they do. Now, let’s assume that the company in the example above never paid. The $1,000 is written off as bad debt. To make up for the bad debt, the company would have to sell $19,000 (($1,000 – $50)/.05) just to break even on the invoice that was not paid. If the credit staff does its job correctly, neither loss will occur. Later in this chapter, we will discuss those occasions when credit standards may be loosened to intentionally allow for bad debt. This is sometimes done when a company decides that the bad debt written off will be more than compensated for by additional sales. 2 The First Step: Approving the Credit Sales Prevention Depar tment— Not! As can be seen from the simple examples above, the functions of the credit department often come in direct conflict with the sales department. This sometimes leads the sales department to refer to the credit depart- ment as the sales prevention department. Nothing could be further from the truth. It is the function of the credit department to work to make sales (not gifts) happen—if at all feasible. Chapter 6 will introduce you to a variety of ways that sales and credit can work together. Open Account Credit would not be a problem if companies bought and sold goods the way individuals do.When most people need something, they go to the store and either pay cash or use a credit card. In either case, the store gets its money within a day or two. Businesses do not operate in that manner. The preferred way of operating (at least from the seller’s stand- point) is to order goods and pay for them at a later date. This is referred to as open account. When goods are sold on open account terms, the seller ships the merchandise and then expects to be paid at some point in the future, say 30 days after the buyer receives the goods. Discounts for Early Payment In many industries, a discount is offered for early payment. The most common discount offered is 2% discount if the invoice is paid within ten days. You may remember seeing the term 2/10 net 30 in your old accounting books. If it is not paid within the discount period, then the full amount is due on the due date, which in the example here would be 30 days. Other terms sometimes seen include 1/7 net 10 or 2/10 net 11. The first allows the buyer to take a 1% discount if the invoice is paid in seven days, otherwise the total is due in ten days. The latter permits a 2% discount if the invoice is paid within the first ten days, otherwise the 3 ESSENTIALS of Credit, Collections, and Accounts Receivable total is due in 11 days. In both of these examples, it is expected that the purchaser will take the discount unless it is experiencing financial problems. Those who have been in the profession for some time are probably aware that many buyers take the discount and do not pay within the dis- count period. This is referred to as an unearned discount. In some indus- tries this is a massive problem. Techniques to deal with this issue will be discussed in great detail in Chapter 5. Terms Preferred by Sellers Most sellers would like to sell on a cash-in-advance (CIA) basis. The problem with CIA terms is that, with very minor exceptions, few com- panies would purchase under those conditions.Thus, companies, and more specifically the credit staff, need to find ways to quantify risk and identify those customers who will pay if sold on open account terms. They also need to find ways to sell to those who don’t “qualify” for open account terms. These alternatives are discussed in Chapter 8. Credit Repor ts Most credit professionals begin building their “credit case” with a cred- it report, usually pulled from Dun & Bradstreet (D&B), although spe- cialty reports are available from other agencies. Even if only a minimal credit investigation is to be done because the potential sale is small, many credit professionals still pull a credit report to verify that the busi- ness is legitimate and not a fly-by-night involved in a scam. The report will also tell you how long the company has been in business and who the principals are. It should also provide the legal name of the entity, which is important. If the credit application is filled out and signed in the incorrect name, you may find yourself with no legitimate business to go after if the invoice is not paid. 4 The First Step: Approving the Credit Verifying the Company Small companies and those just starting out may not have credit reports. When trying to verify the business, do not use the phone numbers pro- vided by the company. Look them up in the phone book or call infor- mation to get the information. Why? Check this information from third-party sources to avoid being taken by individuals looking to scam your company. The same is true when checking trade references. If the reference is from ABC Company, call information and get a phone listing Y for ABC Company. Then use the phone number provided by informa- FL tion to check the reference.Why? A fraudster may provide you with the name of a very impressive company for a reference but actually have a AM friend or associate provide the reference. If you call using the number provided, you will be connected to the accomplice rather than a legit- imate reference. TE Trade References Before extending credit on open account terms, most companies will check trade references to see how the potential customer pays its bills. Typically, the potential customer will provide the names of the refer- ences, along with the phone numbers. Now, like most people, they will only provide the names of companies that will give good references. Once the credit professional has contacted the trade reference using phone numbers obtained from information, he or she should try and ascertain other companies that the potential customer has done business with. Once the other companies have been identified, the credit professional can contact them, if possible. This needs to be done care- fully. One of the best ways to find out about a potential customer is from credit industry groups. If you belong to such a group for your industry, check its latest reports to see how the potential customer has paid your peers. 5 Team-Fly® ESSENTIALS of Credit, Collections, and Accounts Receivable Financial Statements Financial statements are typically used to paint a picture of the financial health of the company. However, as credit professionals are well aware, numbers can sometimes be manipulated. Thus, it is important to have statements that are audited by an independent accounting firm. Financial statements come in three levels: 1. Audited statements are compiled by an independent accounting firm from company records. This is the preferred type of state- ment. The audit firm signs off on the statements when the audit is complete. They typically state that the accounting conforms to generally accepted accounting principles (GAAP). This is referred to as an unqualified and it is what credit managers ideally want to receive. If the accounting firm disagrees with the way the company handled one or more transactions believing the issue does not conform to GAAP, it will give a qualified statement. Companies generally will go to extreme lengths to make sure that their audi- tors give an unqualified statement as many believe a qualified state- ment is a sign of bigger problems. It can also trigger an investigation from parties such as the Securities and Exchange Commission (SEC)—something virtually every company would like to avoid. 2. Reviewed statements are what they indicate. The audit firm reviews the numbers put together by the client, but the account- ants have not audited the company’s procedures. 3. Compiled statements are put together on the basis of information provided by the company to the accountant. The accounting firm has no way of determining if the numbers are accurate or if the company has complied with GAAP. 6 The First Step: Approving the Credit Financial Statements—Age The more current the statement, the more reliable the numbers will be to the credit manager using the information to complete a credit eval- uation. Typically, the numbers may be as much as 18 months old. Here’s why. The accountants only audit once a year and this is done after the fiscal year-end. Thus, already some of the information is a year out of date. Then the company must complete the audit and prepare the financial statements. This can and usually does take several months. However, new statements should be available six to nine months after the end of the fiscal year. If they are not, it could be a sign of financial difficulties. Additionally, credit professionals are well advised to look twice at customers who change their fiscal year-end.Very rarely is there a good business reason for making the change, often the change is done to hide something. Thus, whenever a change is noted, question the customer for the reasoning behind the change. What Is Included in Financial Statements? Several important documents are included in the general term financial statements. Income Statement. The income statement is the starting point for most credit investigations. It tells the profit-and-loss story for the current fiscal year. Examine the statement closely for any unusual or nonrecurring items, such as the sale of a facility, a change in account- ing methods, a large tax credit, or a write-off. If you find such items, recalculate the income statement, and then redo your ratio analysis based on the new numbers. After all, if the only reason a company showed a profit was that it sold a piece of real estate, this is a one-time gain that is unlikely to happen again. 7 ESSENTIALS of Credit, Collections, and Accounts Receivable Once you have the new ratios, compare them to industry standards to see if they are normal for the industry. If they do not fall within the accepted ranges, you will have to find out why the ratios are off. Also take a close look at the statement of stockholders’ equity to see if there have been any significant changes for the period the income statement covers. Again, if there were big changes, such as the owners making a capital contribution or the sale of new stock, you need to determine the reason for the change. Balance Sheet. The balance sheet, sometimes called the statement of financial condition, shows the financial condition of the company. It reflects both long- and short-term assets and liabilities. Cash Flow Statement. Although traditionally the cash flow state- ment was not deemed to be that important, increasingly it is seen as vital to those analyzing the financial condition of a company. It shows the cash inflows and outflows of the customer. It is especially impor- tant to credit professionals who are very concerned about making sure the customer has adequate cash flow to pay all its short-term obliga- tions, especially vendor obligations. Some even call cash flow the lifeblood of any organization. Anything that adversely affects it needs to be examined closely. Footnotes. Some of the most important information about a company is hidden away in the footnotes. Long and complicated foot- notes deserve extra attention. Again, they do not necessarily mean bad news, but they do need to be inspected closely. Additionally, they may provide invaluable information that is not included elsewhere in the financial statements.What kinds of information might you find? Details about lawsuits pending against the company, use of tax credits, the con- dition of the pension plan, and the status of leases and mortgages or deferred compensation commitments. Information about certain con- tingent liabilities will also be buried in the footnotes. 8 The First Step: Approving the Credit Most customers will not voluntarily offer this type of information to their creditors. You must find it. These facts can often have a nega- tive bearing on a credit decision—provided you unearth them. Ratio Analysis It is recommended that trend analysis be used when evaluating the bal- ance sheet, income statement, statement of cash flows, and ratios. Ideally, five years’ worth of data should be used. Trend analysis is the comparing of key ratios from each year against industry norms to pin- point movement toward improvement or decline in a business and to identify unusual items. No ratio can be looked at in isolation. For example, most credit professional believe that a quick ratio of 1 is a good indication of a finan- cially stable company, but it is important to do a little digging into that number. The quick ratio is defined as cash, marketable securities, and accounts receivable divided by current liabilities. If the company with a quick ratio of 1 also has a days sales outstanding of 65, when the industry norm is 45 that quick ratio no longer looks so good. There might be receivables that are not collectible. Thus, the quality of the accounts receivable must be good in order for that quick ratio to mean anything positive. Listed below are the seven ratios credit professionals can use when evaluating unsecured trade creditors along with an indication of what the ratio signifies: 1. Quick ratio defines the degree to which a company’s current lia- bilities are covered by the most liquid current assets. 2. Days sales outstanding (DSO) shows the average days it takes for the customer to collect its receivables. 3. Accounts payable turnover shows the average number of days that it takes the customer to collect its receivables. 9 ESSENTIALS of Credit, Collections, and Accounts Receivable 4. Inventory turnover shows the average days that the customer takes to turn its inventory once. 5. Debt to tangible net worth indicates the ability of a firm to lever- age itself. It shows how much the owners and creditors have invested in the firm. A high number reflects a potential danger to all creditors. 6. Gross profit margin is only meaningful when compared to the industry. 7. Return on investment reflects the efficiency of management’s per- formance. Caveats Once these ratios are calculated for the time when the data is available (remember, five years is the best), the changes can be noted and a trend established. From that, it is possible to make a prediction and arrive at a credit limit. In making that decision, it is important that: The data be devoid of any large, unusual, nonrecurring items Any recent changes be incorporated into the data, such as a major acquisition, a bankruptcy filing, or a spin-off of a major product line The same formula that is standard in the industry be used Data be compared to others with the same Standard Industry Classification (SIC) codes and in similar narrow-dollar sales ranges Commonality in how industry numbers value inventory and how customers compute depreciation is uncovered. This can usually be found in the notes section of the annual report The footnotes in the annual report be checked carefully for unusual or one-time occurrences that will affect the company’s results. Some companies have been known to bury unpleasant news and negative financial data in the footnotes. It is not unusual for such facts to be overlooked 10 The First Step: Approving the Credit Cash Burn Rate What do you do when you’re asked to extend credit to an Internet start-up? Most credit professionals realize that the traditional methods of analyzing a company will not work for their new Internet cus- tomers. Forget comparing data for the last five years—many of these companies have not been around long enough to have two years of audited financial statements. First of all, refusing to grant credit on any terms other than cash in advance is probably a wise course. Few companies would stand for that, although it is not a bad idea in the case of truly shaky firms. Liquidity can be a real issue for Internet companies. Those who follow the financial and Internet news probably are accustomed to hearing the analysts talk about Internet companies running out of cash. Some refer to this as the cash burn rate or the cash burnout rate. To calculate this number, add cash to marketable securities and accounts receivable (A/R). This number should be divided by daily operating expenses and then 365. This will give an indication of when your Internet customer could run out of cash. The answer to this cal- culation will guide you in the credit decision. It can also help to get management to see why you do not want to extend credit, if that is the case. A visual depiction of the cash burn rate is: Cash + A/R + Market Securities (Daily Operating Expenses)(365) Some credit professionals like the cash burn rate concept so much they have incorporated it into their financial analysis of existing customers. Nonfinancial Factors That Affect the Credit Decision As virtually every credit professional knows, making a credit decision is as much an art as it is a science. The stark financial analysis may indicate 11 ESSENTIALS of Credit, Collections, and Accounts Receivable that the customer should not be granted credit terms, but there are often other factors to be considered. Here is a brief look at some of the nonfinancial issues that affect the final determination: The 5 Cs of credit: character, capacity, capital, conditions, and col- lateral. One credit analyst revealed that his company routinely sold on open-account terms to a customer, whose numbers were awful. The reason was simply that this company always paid its bills and was never late. “I’d rather deal with this cus- tomer any day,” says the analyst, “than those large companies who continually string us along for payment even though they have the money.” Relationship with the buyer. Oftentimes, if a long-term ongoing relationship with a customer exists, credit executives are more likely to allow the company to go over its credit limit. How- ever, watch the payment patterns closely if this is allowed. Most credit professionals who follow this strategy do it with customers who have seasonal businesses. The customer’s payment history. If it is good, some credit pro- fessionals are apt to be more aggressive in finding ways to grant open-account credit terms. However, if it has been bad, most in the group indicated that they would be inclined to reduce the credit line if the sales force didn’t squawk too much. Profit margin on the product in question. Without a doubt, a company that sells products with tight margins were much less likely to be flexible when extending credit. “We just can’t afford to be wrong,” explains one weary credit professional. However, those with wide margins were more apt to stick their necks out a bit and extend credit. 12 The First Step: Approving the Credit Status of the product. Is it already manufactured and sitting in the warehouse? If so, the sales force is likely to bring this to credit’s attention, especially if the end of the season for the goods in question was approaching or if the product had been moving slowly. At this point, some credit profes- sionals are more likely to get creative to find ways to make the sale happen. Status of sales goals. Is the sale needed to make the budget? Unfortunately, as the accounting period ends, many credit professionals find themselves being pressured to grant credit for sales that don’t meet credit standards. Several report that this happens with greater frequency if sales goals are not met. Role of sales. Will sales be willing to get involved in collection efforts should the customer not pay? While most salespeople are reluctant to get involved with collection efforts, several of the credit professionals indicate that they are able to exact a promise to help in exchange for extending credit in marginal cases. However, most who were able to do this say that they did this mostly with customers who were late payers. The preference of the group was to tie the salesperson’s commis- sion to the payment of the accounts receivable but few are successful on that front. Customer’s cooperation. Is it possible to obtain a partial pay- ment up-front to cover costs? In cases where the credit of the customer is questionable and the margins on the product high, a number of credit professionals simply ask for cash in advance for the portion that relates to the out-of-pocket costs. Then if the final payment is not received, the company only loses its profits. This also demonstrates to the customer a 13 ESSENTIALS of Credit, Collections, and Accounts Receivable willingness to work together. Several who have tried this approach with new customers say that they are ultimately able to convert these accounts into long-term quality customers. Mean versus ends. Can this sale be used to leverage payment on an outstanding order? There is nothing more frustrating to a credit professional than to be approached by a salesperson to extend additional credit to a customer who is already late paying other invoices. However, should the customer really want the goods, it may be possible to make the sale if the cus- tomer agrees to pay the outstanding invoices. Ideally, such a customer should not only pay the outstanding invoices but make a partial prepayment on the new order. If, after taking all the factors discussed above into account, credit cannot be granted, credit professionals should look for another “creative” way to grant the credit even if the customer does not meet financial stan- dards. Not only will the company get the sale and have a higher profit, the sales force will appreciate the efforts. How Dif ferent Companies Review New Accounts Not all companies review credit in exactly the same manner. Depending on the nature of the business, the corporate culture, the resources devoted to the credit review process, and the amount of credit granted with open terms, companies set credit review guidelines. The range of what is done is quite wide. The following list includes just a few of the ways companies evaluate credit. Every new customer must complete a credit application. Have credit policies and procedures in writing and have them approved by senior management. This approval helps the credit department should sales try and bend some of the rules. 14 The First Step: Approving the Credit Call all new customers and explain discount terms. Encourage customers to call before taking any deduction. New credit applications are reviewed thoroughly and ques- tionable accounts put on cash-on-delivery (COD). Use multiple sources of information, including the Internet, to obtain factual data on companies. Pull credit reports on new customers over the Internet, allowing quick turnaround on credit applications. Y Sales and credit review customer programs in detail. FL Profitability analysis, capacity, and other key factors are all part of the credit line granting process. AM Have the board of directors revise and clarify credit policy and terms. Divide the credit application into two parts: the credit agree- TE ment and the application for credit. Streamline the new account set-up process. Assign one person to set up new accounts, send out credit applications, and process them once they are completed and returned. Have all customers complete an application and a customer profile so the credit analyst can see the big picture. Redesign the credit application so it is easier to fill out. Elim- inate any meaningless requirements and add slots for e-mail addresses and customer Web sites. Set up form letters on the personal computer (PC) to autofax for credit references. Require bank/trade references with completed credit application. Work with sales on the credit application process. Make sure they get a signed contract and authorization rather than just a verbal commitment. 15 Team-Fly® ESSENTIALS of Credit, Collections, and Accounts Receivable Make the credit approval for all new customers consistent. Require the same information from all before credit is granted. Once the process is standardized, the sales reps know what will be required and make sure the customers supply it. Automatically give new accounts a small credit line with minimal credit checking. Then reevaluate based on financial information and payment habits. Formalize a thorough process involving pulling credit reports, reviewing the customer’s completed credit application, and accessing financial information over the Internet. Have a training program for the existing credit staff to make sure they all understand the nuances of credit and are using the same corporate standards. Hire a full-time credit administrator to monitor the credit- approval process. Existing Accounts Just because a rigorous credit evaluation was completed when a company first becomes a customer does not mean that analysis is good forever. Most experts recommend that credit reviews of all accounts be done at least once a year. However, the reality is that ongoing credit reviews are one of those things that get pushed back when the credit staff does not have enough time to do all the work that it has on its plate. IOMA sta- tistics show that only about 50% of all companies review all accounts annually. This is too bad because long-term customers do run into finan- cial difficulties and it would be nice if you were able to cut your firm’s exposure before the customer can no longer pay. Here’s a sampling of how some companies review the credit limits of their existing customers: Each month, the computer generates a list of all customers that are up for their annual review. 16 The First Step: Approving the Credit Request updated financial statements from major accounts. Also pull updated D&B reports, and get trade credit reports from local trade groups. Review current credit limit and past payment history to determine if higher credit limits should be granted to each customer once a year. Review existing accounts with controller once a year and discuss the status of each. During the slow time, the top 75 customers are reviewed. For some companies the slow time is May, June, and July, but it may differ for other seasonal businesses. Depending on the level of activity in the account, each cus- tomer is reviewed annually or semi-annually. Only review the top 25 customers each year. Customers with large balances or changes in their payment habits are reviewed each year. Continually monitor largest customers. Any customer who has not done business with the company in over a year is forced to go through a new credit check. Accounts are all set up for annual review by placing an indi- cator in the sales system. The list is printed monthly and the accounts updated. Depending on the credit limit, the update may consist of obtaining new financial statements, updating credit reports, and trade and bank references. Have procedures in place to request financial statements annually. Input the follow-up information into a credit rating model. Those customers whose ratings come out poor or marginal are then reviewed in greater detail. Depending on the size of the company and whether it is pri- vate or public, the financial statements are reviewed, references 17 ESSENTIALS of Credit, Collections, and Accounts Receivable are updated, and the past history with the company is reviewed. Credit limits are reset based on this evaluation. If a customer consistently bumps up against its credit limit but pays within acceptable limits, the limit is reviewed. If the pay- ment history is not acceptable, “the whole enchilada” is done again. Accounts due for annual revision are compiled in a monthly report. An analyst uses the report to determine which accounts need to be reviewed. The credit manager and the assistant credit manager review customers’ creditworthiness along with input from the sales- person. Pull simple Experian credit reports to show changes. Look at the payment record and sales levels to determine next action. Update data by mail and phone. Update information from the credit bureaus and National Association of Credit Managers (NACM) reports. Use credit scoring to determine which accounts get reviewed. Only review major accounts. Review annual reports and a three-year spreadsheet. Also discuss the customer at credit groups. Run reports to show which accounts have orders that will exceed their credit limits. These accounts are then reviewed. Evaluate current payment patterns, and update trade refer- ences and financial information for a formal review of the credit limit. New credit reports, financial information, and trade references are assembled. A log is kept of all files in review. A recap sheet is completed for management review. A last review date is updated in the computer. Only accounts with large credit lines are reviewed. 18 The First Step: Approving the Credit Maintain a monthly analysis of all customer credit lines and sales and payment methods. Conduct a thorough analysis two to three times a year with upper management and monthly meetings with the depart- ment staff. Set a goal of having all accounts updated every 18 months. Get a monthly listing of all accounts that have not been updated within this time frame, and make sure an account’s last review date shows on all accounts receivable screens. Review those accounts that are very active and purchase over $100,000 each year. For some companies, an annual credit review is an audit requirement. All accounts carry an annual review date, which posts automatically to an exception list. Every account is reviewed for performance and appropriate file support (latest trade and bank references, and so on). Set the system to flag any order that has not been reviewed for 12 months. Credit is notified and depending on the order value, the history is reviewed, a new credit report is pulled, and a decision is made to extend or change limits for the upcoming year. All credit managers review their areas of responsibility in total. Also, a credit check program alerts if a credit is more than 12 months old. Based on average accounts receivable balances, reviews are done quarterly, semi-annually, or annually. New financials and trade reports from industry groups are obtained. Any other information with the exception of new trade references is also acquired. If the customer is international, a country report is also pulled. Run customer profiles and go through an average days of payment to try and pinpoint potential trouble before it occurs. 19 ESSENTIALS of Credit, Collections, and Accounts Receivable During the first quarter, accounts with limits over $25,000 are reviewed. In the second quarter, those with limits between $10,000 and $25,000 come under scrutiny. The third quarter is spent focusing on those with lower limits, and the fourth quarter is spent making sure that credit files for every active account are in place and updated. Credit professionals should try to review existing accounts at least once a year not only because it is a good business practice but also to protect themselves.When the credit review is done, the documentation should be put in the file and any recommendations should also be filed. If management overrides you, it is imperative that at a minimum a note to this effect be put in the file. Ideally, the override would be in writing—but that is often difficult. The reasons for this are fairly simple.When one of these marginal accounts goes bankrupt and ends up owing your com- pany thousands (or more) of dollars, management is going to point a TIPS & TECHNIQUES Watch Out for Large Exposures When reviewing a potential customer’s credit application, some credit professionals believe in looking at that customer’s ten largest customers to see what the total exposure is. Be careful if one customer represents too large a percentage of your potential customer’s business. If one of their large customers goes broke, there could be financial implications for your company. Think this can’t happen? Just look at some of the big companies that have experienced financial difficulties and have even gone out of busi- ness. There was a time when Lucent was golden, but as this is being written Lucent is fighting for its financial life. Most compa- nies limit their exposure to any one company to no more than 5 to 10% of their total business. 20 The First Step: Approving the Credit finger at credit and ask “why wasn’t credit on the ball to see this trouble coming.” If you have a notation in the file that you warned manage- ment and sales, and they decided to ignore your advice, you will avert the blame. They still won’t be happy with you, but at least credit won’t shoulder the full responsibility for the loss. What Should Be in the Credit File? When taking legal action because of nonpayment or bankruptcy of a customer, some credit managers find they do not have the information they need. If the facts and figures were not collected when the account was first opened, the customer will probably not provide them when the account gets into financial difficulty. This information is not difficult to obtain when the account is first set up. The customer is interested in putting on a good face with the vendor.While amassing these reports for each new customer may seem a waste of time, the credit professional will be paid back many times over for this effort when the account goes bad. So, exactly what should you keep in debtors’ credit files? The fol- lowing information comes from Creim, Macias & Koenig, LLP. Basic Information The data listed in this section are usually needed to prepare documents. While it seems elementary, some credit professionals report it missing from their files. It includes: The identity of the debtor, including its correct name, form of business, and whether it is one entity or multiple entities Locations of the debtor Locations of the debtor’s assets Value of collateral Form of debt (invoices, statements of accounts, promissory notes) 21 ESSENTIALS of Credit, Collections, and Accounts Receivable Creditor Documents “A credit application,” says Bill Creim, one of the firm’s partners,“is the one document the debtor signs, so include all areas where difficulties are likely to arise.” He recommends including terms, conditions, and whether interest may be charged on late payments. He delineates the items that should be included in the file as follows: Credit applications, security agreements, dealer agreements or distributor agreements, sales contracts, guarantees, and other written correspondence showing Interest Attorney fees and collection costs Acceleration Debtor’s books and records Jurisdiction and venue clauses Arbitration clauses Financial information including D&B, Experian, or other credit reports Audited financial statements Unaudited financial statements Unmarked original documents and letters contained in credit manager’s and salesperson’s files Invoices and statements of account. Creim warns credit pro- fessionals to beware of usury problems, collection costs, and payment terms. Other Sources of Information In addition to the details listed above, miscellaneous intelligence—such as information from banks, other creditors, or competitors—should be 22 The First Step: Approving the Credit TIPS & TECHNIQUES Checking Out New Customers The old adage, “if something looks too good to be true, it probably is,” is especially pertinent to credit professionals when they check trade references on new clients. A potential customer gives you the names of three companies and contacts there. You reach all the contacts, who respond that the customer pays bills on time and is no problem. What could be wrong with that? A lot, says D&B. You should be suspicious if a reference uses only superlatives to describe the customer and doesn’t need to look up the customer’s records. Also think twice if a hard-to-trace fax number is the only way to reach a reference: You don’t really know who’ll receive the fax. Here are some suggestions from D&B on checking on references before you rely on them to support the potential customer: Check with the Yellow Pages or other outside sources to confirm that the reference company actually exists. Call information and ask for the phone number of the refer- ence company. See if it’s the same as the number the potential customer gave you. Make sure the person you speak to really works for the ref- erence company and is in a position to speak for the com- pany. Ask to speak to the credit manager instead of the person whose name was provided. Make sure the reference is in a business in which the cus- tomer could logically be expected to work. Will these steps guarantee that a phony reference won’t sneak past you? No, but following these simple procedures certainly will make it more difficult for someone trying to pass bogus references. 23 ESSENTIALS of Credit, Collections, and Accounts Receivable included. Creim warns credit professionals that they must make sure that nothing in the file could be misconstrued as slander or interference with normal business relationships. Credit professionals must also omit anything that might show antitrust violations. Much of the material kept in the credit files needs to be updated regularly. New financial reports and sales contracts should routinely be included in the credit files. Similarly, new credit reports should be pulled periodically to make sure your customer’s financial standing is as good as (or better than) it was when the account was first opened. In the current environment, which Creim describes as “we cheat our suppliers and pass the savings on to you,” it is imperative that credit pro- fessionals do everything to protect their companies against nonpayment. Some companies actually have the information discussed above but cannot find it when it is needed. The importance of having all relevant documents in one place should not be underestimated. IN THE REAL WORLD The Credit Application... Circa 1892 Speaking at the FCIB’s Global Credit Conference, Credit2B.com’s Al Carmenni shared some requirements he’d located on an 1892 credit application. That’s right, he was in possession of a credit application that was over 100 years old. It had about 40 questions. Some focused on financial issues, as might be expected. However, the following, rarely found on credit applications today, caused the audience to laugh. The application inquired about the principals’ drinking habits, wanted to know if the principals were racetrack fol- lowers, or if they were politicians. 24 The First Step: Approving the Credit Setting a Credit Limit Most credit professionals believe that setting a credit limit is as much an art as it is a science. Some companies use a simplistic approach offering customers 10% of the customer’s net worth capped at some level. For example, most vendors with annual sales of $100 million will never offer a customer a line of more than $10 million. The reason is simple —the vendor simply cannot handle the limit no matter how good the company, and it is also a very poor idea. Most companies like to limit their Y exposure to any one company, never allowing one company to represent FL more than 10% of its annual business. Others use a formula based on the customer’s financial numbers. AM Warning Signs TE Alert credit professionals will find signs of potential trouble in their day- to-day operations. The following are some signs that might signal trouble: A normally prompt paying customer begins to take longer and longer to pay its invoices. A small customer suddenly places a much larger order than normal. Other credit managers report late payments at industry group meetings. Sales finds a new customer that must have a large order quickly. A customer that took minimal deductions suddenly starts taking large deductions. Types of Credit Repor t When most people think of credit reports, they think of D&B reports. These reports contain much information that might be useful to credit professionals. Some in the field are less than impressed with D&B reports 25 Team-Fly® ESSENTIALS of Credit, Collections, and Accounts Receivable —yet, despite the complaints, most credit professionals use D&B reports. The reports are good for verifying that the company exists. However, when it comes to financial analysis, do your own. Also, realize that the information is sometimes outdated. The second runner-up in the credit-reporting field for businesses is Experian, formerly known as TRW. The company’s reports are not used widely in the United States but have a wider exposure in Europe. Other reports are available from NACM affiliates, Riemer, and other specialty credit associations. I nternational Customers One of the biggest mistakes companies make when they first dip their toes into the international arena is to assume that business overseas runs the way it does in the United States. That simply is not the case and pro- ceeding using that assumption is likely to get a company into big trouble. The second biggest mistake made by more than a few companies is to throw credit considerations right out the window. These companies decide that evaluating international credit is very difficult and therefore they won’t even bother. Thus, they end up granting credit to every cus- tomer that shows up including those that they would never offer open- account terms to had they been a domestic customer. Selling to companies in other countries requires different approachs than when selling domestically. For an in-depth study, see International Credit and Collections (Schaeffer, New York: John Wiley & Sons, Inc., 2001). C redit Software To help with credit- and collection-related issues, many professionals use specialty credit software. It is used for credit analysis, scoring to help with collections, and a myriad of other credit-related issues. It is dis- cussed in some detail in Chapter 11, which addresses technology issues. 26 The First Step: Approving the Credit S ummary As you can see, there isn’t only one way to analyze credit. The approach selected by each company will match its industry needs along with the resources it is willing to devote to the credit process. By evaluating the discussion above and reviewing some of the techniques used by different companies, you will be able to devise the best credit approach for your company. 27 CHAPTER 2 The Second Step: Billing After reading this chapter you will be able to Understand the implications of billing on business credit and collections Prepare a clear and accurate invoice that does not prevent your company from being paid in a timely manner Recognize the effect terms can have on collections Implement electronic billing in your organization ften overlooked in the business cycle, the billing process, handled O incorrectly or inefficiently, can cost a company thousands of dollars. Those credit professionals looking to improve their collection results should begin by looking at the billing process. What Is An Invoice? Simply put, an invoice is a bill. It provides the customer with the nec- essary information to pay for goods ordered and delivered. It should also include any other pertinent information needed to pay the invoice in a timely and precise manner. 29 ESSENTIALS of Credit, Collections, and Accounts Receivable When Should the Invoice Be Sent? Invoices should be sent as soon as possible after the goods have been shipped. The reason for this is simple. Let’s say your payment terms call for payment in 30 days. Most customers will start the clock counting from the time they receive the invoice. Thus, if you only send out invoices once a month, some customers may actually take 60 (or more) days to pay. Now some reading this may declare that the terms are from the invoice date. However, that is not how most customers will count. Addi- tionally, it takes most companies time to process invoices for payment. In many organizations, the invoice must be sent to the purchasing depart- ment for approval and then back to the accounts payable department for payment. These steps take time as approving an invoice is not typically a high priority. Also, the customer is in no hurry to make payment so the longer you delay in sending an invoice, the longer it will delay in making payment. While printing invoices every day may not make sense for mid-size and smaller companies, once a month might not be an ideal solution either. Once or twice a week might be a reasonable approach. Terms The payment terms indicate when an invoice is supposed to be paid. Few organizations will pay early. Many will pay late. It is the goal of the credit department to get as many customers to pay as close to stated terms as possible.The most desirable terms are referred to as open account. This means the customer is given the goods and does not have to pay for them for some time. In many industries the terms are net 30. This means that the customer is expected to pay in 30 days. Here’s where it gets a little vague. The seller wants the invoice paid within 30 days of the invoice date. However, most customers believe that the payment is 30 The Second Step: Billing due 30 days after receiving the invoice—hence the need to get the invoice out quickly. Terms are generally dictated by industry. For example, the food industry tends to have shorter terms, say seven or ten days, while some machinery manufacturers might have longer terms, even as long as 180 days. Those selling internationally will find that most companies in other parts of the world are accustomed to longer terms, with 60 days and longer not being considered uncommon. Sometimes, in order to induce early payment, companies offer a dis- count for quick payment. The much-fabled 2/10 net 30 is a common example. In this case, payment is expected in 30 days. However, if the customer will pay in ten days or less, it may take a 2% discount.While 2% may not seem like a big discount, it translates into an annual return of approximately 36%—a rate that few companies have earned in recent times. The problem with offering discounts to induce early payment is that some customers take the discount but don’t pay early.You will read much about the unearned discount problem in Chapters 3 through 5. It can be a huge problem for some companies. Customers that don’t qualify for open-account terms, either because their credit history doesn’t warrant it, because their payment history is poor, or because they have not offered sufficient financial information or references can still be sold to. It can be done on a cash-in-advance (CIA) basis, a secured basis, or a cash-on-delivery (COD) basis. Secured selling will be discussed in Chapter 8. Cash in advance is preferable to COD because, as some companies have learned the hard way, COD has its pitfalls. Specifically: The person needed to sign the check may not be available when the driver shows up with the goods. No check is available when the goods are delivered. 31 ESSENTIALS of Credit, Collections, and Accounts Receivable The customer changes its mind and does not offer payment when goods are delivered. The customer puts a stop payment on the check after it has accepted the goods. The check bounces after the goods have been delivered. The driver forgets to pick up the check when he delivers the goods. Despite its drawbacks, COD is a viable option, especially when the amount of money is not large. D ue Date As indicated above, customers generally start the clock ticking when the invoices arrive in their office. Sometimes they don’t start counting until the invoice arrives in the accounts payable department. One way to get around this issue is to make the due date crystal clear on the invoice. This will not guarantee payment when you think you should get it, but it will eliminate confusion over the correct date. H ow to Make the Invoice Date Clear There are several ways to make the due date clear. Making the date clear is just the first step in getting paid on time. Several ways to make that date crystal clear to the customer’s accounts payable department are to: Include the due date on the invoice. Don’t leave it up to the customer to calculate the date. They will do the calculation to their benefit, not yours. Include a statement that says “Pay this invoice by...” Bold the due date. 32 The Second Step: Billing I nformation That Should Be Included on Invoices The following information should be included on invoices: Addressing: correct address, company, department, contact person Description of delivery, product/services, quantities, delivery location and date Clear specification of the amount, including possible supple- ments Reference or purchase order number of the other party Order date Person/department who did the ordering Clear statement of payment conditions Clear statement of the desired method of payment Name and direct dial number of the credit manager responsible Are Your Invoices the Cause of Your Collection Woes? After taking a long hard look at their invoices, a number of credit pro- fessionals have discovered that part of their collection problems were self- inflicted. By making sure that the invoice leaves nothing to the discretion or imagination of the customer, these credit professionals were able to plug some of their collection leaks. Credit professionals can take one of their invoices and pretend to be on the other side of the fence. Is the due date spelled out clearly, or is it left up to the customer to calculate it? If there are two ways to interpret the due date, you can be guaranteed that you will calculate it one way and your customer the other. Don’t give your customer this opportunity. Print the due date on the invoice. The same goes for the amount due. Do you leave it up to the cus- tomer to calculate the discount? Make it simple for them. State that x amount is due if the invoice is paid before date 1 and y amount if paid after. Also make sure the invoice is clear and the customer can find the 33 ESSENTIALS of Credit, Collections, and Accounts Receivable TIPS & TECHNIQUES Other Invoice Tips Don’t print invoices on odd-colored paper. Many companies image invoices and you want to ensure that your invoices are easy to read. Don’t print invoices on odd-sized paper. Also, make sure the invoice is of decent size. Make sure the printing on the invoice is clear and legible. Get rid of those old dot matrix printers. Make sure the information on the invoice is clear and precise. Include contact information so customers may contact the appropriate person if there is a problem. Make the due date very clear. While it is a good idea to review large dollar invoices for accu- racy before sending to the customer, realize that you may be cutting into the discount period if early payment discounts are offered. due date and amount due very easily.Where the check should be mailed to after it is drawn should be readily apparent. Many companies increase their float by simply mailing payments to the wrong part of the com- pany. The check then spends a few days in interoffice mail. Finally, even though you have no real interest in increasing the number of calls com- ing into the department, put a name and phone number of the person responsible for resolving discrepancies on the invoice. By making it clear to the customer that you welcome phone calls, they may pick up the phone to resolve discrepancies instead of their calculators to do some creative accounting. 34 The Second Step: Billing Best Billing Practices Every industry has unique billing/payment issues. The publishing industry is no exception. In an attempt to set a standard for reasonable billing practices, the Magazine Publishers of America (MPA) set about to develop a Best Billing Practices Paper. Let me start out by telling you that this attempt did not make the publishers very popular with their customers—the large advertisers and the agencies that represent the advertisers. So, what seems like a very sensible project quickly turned Y controversial. Before casting stones at the agencies, it is necessary to FL understand their predicament. The following three problems only exac- erbated the billing/payment issue: AM 1. Corporate payment stretching policies currently being used by many companies—including many advertisers who delayed pay- ing their agencies TE 2. The agencies were then caught in a bind, not being able to pay the publishers until they had been paid by the advertisers. 3. Disputes Publishers complained that frequently agencies would hold on to large payments when the disputed item was only a fraction of the total invoice. Was the dispute simply a ploy to avoid paying? To address the various problems, the Media Credit Association, a branch of the MPA, developed a draft proposal for industry best practices as they relate to billing and payment issues. Although the final paper was never formal- ly adopted, you can learn from the Association’s proposal and adopt its provisions in your own practices. For those not familiar with the publishing industry, note that many publishers provide tear sheets of actual ads so the advertiser can verify that the advertisement actually ran. Can you imagine what a nightmare this can be for large publishers? Here is the MPA’s proposal: 35 Team-Fly® ESSENTIALS of Credit, Collections, and Accounts Receivable Supply advertisers with either a complimentary copy or an affidavit to verify fulfillment. Ideally, as technology advances, digital images of advertisements could be used to verify fulfillment. Invoices will be prepared promptly and disputes communicated immediately—not after the payment is due. Payment terms are binding unless a deviation is agreed to in writing. Undisputed amounts will be paid in the agreed-upon time frame. Disputed amounts will be resolved quickly. The publisher has the right to notify the advertiser if the agency is more than five days late in paying the publisher. Agencies are not thrilled with this clause. Agree that old rates will be used while new contracts are being negotiated. You can adopt some of the MPA’s suggested best practices into your own billing procedures. Additionally, you should review your own industry peculiarities and find ways to incorporate these requirements into the invoice. E lectronic Billing A paperless office has long been the dream of innovative, forward- thinking credit professionals.While it is not yet a reality, certain innova- tions are bringing this dream closer. Imaging and workflow technology were the first giant steps forward. Lately, there has been another inno- vation that could bring a paperless office within the reach of virtually every accounts receivable department, and make expensive imaging equipment obsolete in the process—electronic invoicing. Five companies spoke about the specifics of the products they offer (no two are iden- tical) and about some of the obstacles billing and accounts receivable 36 The Second Step: Billing IN THE REAL WORLD How US West Perfected Its Billing Process At a recent conference, Larry Rebenack, a director of the customer- billing department, explained how he combats the two issues of late and inaccurate invoices at US West. Typical Problems Once the invoice has been created accurately, it must be mailed expeditiously. Some of the mail problems that can slow its progress include having two different customers’ data in the same envelope. How does this happen? Typical problems include: Having customer A’s bill printed on one side, and customer B’s bill printed on the back Having two different bill pages mingled together Having the bills cut wrong so that both customers’ data are mixed in and mangled Think this doesn’t happen at your company? Talk to your mail center manager before dismissing such thoughts. Rebenack says that these fatal bills rack up costs to his company, because 40% of the time the customers call, with each call costing $50 to $100 to handle. How to Fix It In US West’s case, several steps were taken to reduce the number of fatal bills. Several manual checks are made at the end of the print process to ensure proper printer placement and cutting, for exam- ple. Also, a manual inspection is made of the trayed mail, with two pieces from each tray pulled out and examined. However, much of the error checking can be done electronically. To start with, there are electronic check characters on duplex printers, the cutting machine has gated sensors to ensure a proper cut of 37 ESSENTIALS of Credit, Collections, and Accounts Receivable IN THE REAL WORLD CONTINUED every document, and the mailing machine electronically verifies the barcode in the address window. The “road to perfection” took US West four years, but the effects were dramatic. From March 1996 to 1997, there were 88,576 fatal bills at US West, according to Rebenack. From March 1997 to 1998, there were 577 fatal bills—only about 1% of all that were sent out. Between March 1998 and May 2000, there were no fatal bills. Downstream Automation Rapid automated bill payment processing also helped to reduce the defects in mail. It meant that the scanline had almost perfect read- ability and was in the correct position every time. The automated bill process barcoded every page, which made each bill easier to track along the way. Corner marks, little half-squares in the corner of the bills, visually verify the cut of the paper. Reducing Problematic Return Mail The mail center now monitors the return envelope drop rate, and reviews any maintenance problem associated with the rate. A ven- dor quality program also reduced the amount of problematic reply mail. That is, envelope vendors are expected to provide defect-free products, just as the mail center is, and are held accountable if something is wrong with their product or services. The company also adopted a quality process. For one thing, the process included implementing an easy-to-read duplex multipaneled bill format. In other words, the printers now create bills that are eas- ier to read, which not only help the customers, but allow staffers to quickly notice errors in a spot-check. Other Tips to Improve Invoice Accuracy Additional tips for improving invoice accuracy include: Be aggressive about correcting addresses. 38 The Second Step: Billing IN THE REAL WORLD CONTINUED Track all bills during processing, to verify that a bill was actually mailed. Use one paper size for all types of invoices. By following Rebanack’s lead and working closely with their own mail center managers, credit professionals will be able to improve their own billing process. professionals run into when they try to implement electronic invoicing. These are only a sampling of the offerings currently on the market. Electronic invoicing is the delivery of invoices, most likely over the Internet, to a customer’s accounts payable department in electronic for- mat. No paper is received—although the invoice can be printed at any time—and the accounts payable department can then forward the invoice, via e-mail, to whoever needs to approve it. The information is then also available, without further keying, to be housed on a network for data retrieval. If it is combined with electronic payments, the infor- mation is then forwarded back (without rekeying!) to the vendor. Why Is Electronic Invoicing Attractive? In addition to the elimination of mountains of paper, accounts receiv- able professionals like electronic invoicing because: It eliminates mistakes due to rekeyed information. There are currently fears about the mail. It makes the workflow to route invoices for approval a no- brainer. It reduces costs. It makes it difficult, if not impossible, for others to blame the mail for their own shortcomings in processing paper. 39 ESSENTIALS of Credit, Collections, and Accounts Receivable Usage If this is such a great deal, why aren’t companies signing up en masse? We wondered the same thing and asked the product sponsors. The obstacles include: Cost Implementation time Budget constraints Internal resistance to change Lack of ease of use Difficulty in signing up partners Fear Overcoming the Obstacles Accounts receivable professionals who can determine why their com- panies and their customers are holding back are in the best position to offer a counterargument for why electronic invoicing is the right choice. The recent anthrax scares with the mail may provide the impetus needed for some companies to take the electronic billing plunge—although to date none of the companies interviewed have seen an increase in activity due to mail concerns. If budget constraints or cost are issues, iPayables’ Kim Rawlings suggests presenting “compelling return-on-investment data to build the business case for the initiative.” He is happy to help credit professionals interested in his product make the case. BillingZone recommends the same approach. Its representative points out that Electronic Invoice Pre- sentment & Payment (EIPP) offers both billers and payers a significant value proposition by eliminating paper from the process. It suggests that improved customer service, cash management, and accuracy in tracking and taking discounts are added benefits that can be factored into the equation. 40 The Second Step: Billing Those facing the anonymous complaints of “it will take too long” or “our customers won’t use it” should rely on documentation provid- ed by the service provider.“We lay out a well-defined process and work with clients to ensure that the project is managed,” says Open Business Exchange’s Martha Perlin. Many of these vague complaints vanish when people understand what is expected of them and how the elec- tronic invoicing process will work. Fear of the unknown is a concept many accounts receivable pro- fessionals have encountered when trying to implement a new process. It is also what many are finding when they mention electronic invoic- ing in their own shops. “Validating the concept is probably the length- iest process involved to garner buy-in from companies as a whole,” points out Direct Commerce’s Lisa Sconyers. “Such an application offers big money savings opportunities as well as extreme process streamlining, but our current economic market has instilled fear and conservatism toward implementing new technology,” she concludes. Sconyers has a few recommendations for credit professionals who find themselves facing this dilemma. She suggests they begin by calling and getting a referral from a customer already using the product. She points out that since her company can quickly and efficiently configure and integrate its application in a matter of days, a pilot program will give potential clients the opportunity to test the product firsthand at no risk. Selecting the Best Service A company interested in pursuing the e-invoicing route will base its own decision on its: Existing internal processes Budget Corporate culture Willingness to mandate change both internally and externally 41 ESSENTIALS of Credit, Collections, and Accounts Receivable Check out the Web sites or contact those vendors whose products interest you. Although e-invoicing may seem like a leading-edge approach today, in just a few short years it will be commonplace. Remember when the use of p-cards was considered innovative? IN THE REAL WORLD Specifics of Five E-invoicing Services Name: Xign Collector Company: The Xign Payment Services Network (XPSN) Description: Suppliers submit invoices through electronic file upload or facilitated Web template entry. Buyers configure set- tings and rules for optimal processing of electronic invoices, including automation of data validation, posting, prioritization, routing, and approval (subject to buyer rules). Both parties track status online from submission through receipt of payment. Cost: Both buyers and suppliers pay fees for the services deliv- ered to them. Pricing varies in proportion to the client’s trans- action volumes and to the benefit delivered. Buyers pay an annual subscription fee based on usage volumes. Suppliers pay a modest registration fee and transaction charges based on a percentage of savings from electronic processing. Advantages: Accelerates collection and resolution of disputed pay- ment items Online status tracking from invoice submission through settlement Unlimited remittance data in any format 42 The Second Step: Billing IN THE REAL WORLD CONTINUED Simple, fast, electronic invoice submission Immediate identification of data and PO match exceptions Pinpoint accurate cash receipt forecasting Self-maintained directory information Simple to implement Complete online audit trail Web site: www.xign.com Contact Info: [email protected] (Source: Xign) Name: OB10 Company: Open Business Exchange Description: OB10 is a secure system that facilitates the delivery of invoices between trading partners. Each buyer and its vendors can choose the most appropriate data format, standard, and means of communication. Using sophisticated data-mapping technology, we transform and deliver any invoice from any vendor to any buyer. Cost: For buyer: Setup fee: $20,000 per accounting system/ERP Annual subscription: $10,000 Volume-based pricing per invoice will average $0.25 to $0.75, depending on volume. Charges for optional services by invoice or unit For vendor with accounting system: No setup fee Annual subscription: $750 43 ESSENTIALS of Credit, Collections, and Accounts Receivable IN THE REAL WORLD CONTINUED Pricing will average $0.25 to $1.00, depending on volume. Charges for optional services by invoice or unit For vendor with no accounting system/using OBE’s Web-based invoice creation and delivery: Annual flat fee dependent on volume, with a maximum of $100 per year. No charge for vendors with 12 or fewer invoices per year Advantages: Buyer-driven solution No software or hardware installation Independent of formats or standards Short implementation time frames Quick return on investment Benefits to vendors as well as buyers Solution accommodates all vendor types Secure data storage Full audit trail available to reduce disputes and expedite resolution Web site: www.obexchange.com Contact Info: [email protected] or 212-828-2147 (Source: Open Business Exchange) Name: Direct Invoicing Company: Direct Commerce Description: DCI automates manual, tedious, and error-prone processes between accounts payable departments and their vendors. It provides services to: 44 The Second Step: Billing IN THE REAL WORLD CONTINUED Description: DCI automates manual, tedious, and error-prone processes between accounts payable departments and their vendors. It provides services to: Accept electronic invoices Deliver purchase orders Validate documents according to business rules and pur- chase order information Y Translate between different formats FL Allow vendors to perform inquiries AM Notify vendors of payments and other invoice status changes Facilitate dialogue and dispute resolution TE Route invoices for encoding and approval within organi- zations Cost: Though both buyers and their vendors derive significant benefits from the Direct Commerce services, the fees are paid by the buying organization because they are the recipients of the tremendous cost savings. Its pricing is based on a transac- tion fee, which typically falls into the range of $2 per invoice. Advantages: It offers more than just the electronic delivery of invoices and purchase orders, it actually manages the function- ality and translates the information of the documentation within the processing of the invoice and purchase order (including workflow, matching, data validation, approval escalation). This allows for two-way straight-through processing and accurate information translation between two organizations. Web site: www.directcommerce.com Contact Info: Lisa Sconyers 415.288.9701 or [email protected] (Source: Direct Commerce) 45 Team-Fly® ESSENTIALS of Credit, Collections, and Accounts Receivable IN THE REAL WORLD CONTINUED Name: BillingZone.com™ Company: Billing Zone Description: BillingZone.com’s EIPP service facilitates business- to-business transactions between billers and their payers. BillingZone.com is a simple way to present and pay invoices online and makes the management of complex workflow issues such as invoice routing easy. Payers can receive invoices from multiple billers on a single Web site to review, schedule, dis- pute, and pay invoices. Cost: BillingZone’s fee structure is based on a one-time imple- mentation fee and transaction fees. It offers solutions to both billers and payers with fees based on the complexity of the implementation and the invoices themselves. Its typical imple- mentation fee is less than $100,000. Many companies have paid less than this amount. Advantages: Consolidated solution for billers and payers It is a service, not software. It is bank neutral, not requiring any banking changes. It is payer-focused. Web site: www.billingzone.com Contact info: [email protected] or 877-965-4583 (Source: BillingZone) Name: InvoiceWorks™ and ClearGear™ Company: iPayables Description: By allowing vendors to key or upload invoice infor- mation via the Internet, iPayables eliminates paper from the invoicing process. iPayables makes it possible for invoice payers 46 The Second Step: Billing IN THE REAL WORLD CONTINUED to receive invoices electronically from all vendors and suppliers regardless of their size or technical ability. The InvoiceWorks™ and ClearGear™ applications allow easy routing, approval, and delivery of invoices from vendors and suppliers to payer’s accounts payable systems. Cost: Initial setup and implementation is less than $100,000. Per-invoice transaction fee of $1.45 or lower depending on invoice volume. Annual maintenance is $15,000. All paid by clients. No charge to vendor/supplier to use service. Advantages: Reduce invoice-processing cost by 70% to 90% Strengthen vendor relationships Eliminate data entry Reduce processing time from days and weeks to minutes Detailed history and audit trail Eliminate lost invoices Reduce clerical staff by 30% to 50% and reassign existing staff Keep labor costs under control Dramatically reduce vendor inquiry calls through online tracking and status Capture more negotiated term discounts Eliminate keying errors Reduce discrepancies, costs, and processing time Web site: www.ipayables.com Contact Info: [email protected] or 877-774-7932 (Source: iPayables) 47 ESSENTIALS of Credit, Collections, and Accounts Receivable S ummary Billing is an important function that affects the bottom line. If done as efficiently as possible, collections will come in faster increasing invest- ment income or decreasing borrowing expenses. It is a function that is often overlooked when companies are looking for ways to become more efficient. Thus, by making recommendations for change in this area, credit professionals can make a difference. As companies continue to look for ways to cut costs and become more efficient, electronic billing will become a more common tool in corporate America. Those who understand what is involved will be well armed to advise their companies. 48 CHAPTER 3 The Third Step: Collecting the Money After reading this chapter you will be able to Understand where collections fits into the big picture Evaluate different collection techniques Know when to turn an account over to a collection agency Realize when a lawyer is needed to approach the debtor here is an old saying in the credit profession that says, “a sale is a T gift until the invoice is paid.” It is the job of the collectors to turn those gifts into sales. If customers paid what they owe when it was due, there would be no collection jobs. However, as those involved in the field are well aware, not only are companies not paying their bills on time, there is a growing trend toward paying them later and later. Thus, the need for collectors with good skills is stronger than ever. There are a wide variety of approaches that can be taken to collect money and collect it faster. The traditional collection tool was a letter. While this is still used, and we’ll share some collection letter techniques that work, many look down on this approach. The phone is the approach that many deem the most successful for generating payments. In this electronic age, fax machines and e-mail are also used. This chap- ter breaks down collection advice into these groupings along with offer- ing some general advice and some techniques to use to get the sales 49 ESSENTIALS of Credit, Collections, and Accounts Receivable force to help. Finally, we will also share a few other approaches that col- lection professionals have used with success. General Advice Many credit professionals believe that the collection process begins when the credit application is first taken. By spelling out in the credit application the terms of sale and any penalties that may accrue due to late payment, credit professionals are laying the groundwork for their collection efforts.While there are many different ways to go about col- lecting, some of the suggestions fall under the classification of general as they apply to more than one area. TIPS & TECHNIQUES Collection Tips from the Field: General Anticipate, wherever possible, the customer’s needs. Become best friends with the accounts payable manager at the corporate headquarters. Become a squeaky wheel with your largest delinquent cus- tomers. Let them know that you have no intention of going away until you have been paid. This will help with the cur- rent collection and future ones, as well. Become the squeaky wheel who gets paid first. Begin follow-up efforts earlier. Build a strong relationship with your customer’s accounts payable manager. Communicate immediately with a past-due customer via an invoice copy and a computer-generated message. Follow this up with a phone call.