accounting & finance

Is it not bad enough in the tough economic climate many businesses are now facing, that credit risks are high? In any business, its ‘paying’ customers are its life and death – While their ability may be a different story, their ‘paying-now’ action differentiates a lot from cash flow reports to balance sheets. But these days, credit terms get more elaborate and if you cash flow is weak on your side, you’d better not consider this blood-sucking option.

The pay “NOW” and pay “THEN” factor varies from industries to industries, products to trading cultures. Financial controllers often take into consideration three (3) parts of assessing credit risk – Defaulting probability, credit exposure and recovery rate.

When credit is DUE

CFOs’ often have a list – What to look at first. Financial controllers have always topped ‘credit risk’ in their list of things to look at. Yet, there is always lack of action. Not only that is the problem, CFOs’ also refuse to move away from traditional credit practices to assess risks. They simply cover reports from credit risk companies (and often at a high price), slap some conclusions and recommendations in and voilà.

Traditional and common steps often taken to reduce credit risks are:

1. Deliver ONLY if COD (Cash on Delivery) is accepted by the buyer.
2. “Net 30″ credit terms – Literally means “Pay in 30 days from the invoice date or else…”
3. “Net 15″ credit terms – Literally means once the invoice is issued (invoice date), payment is due in 15 days. Variations: (x% 15, Net 30); (-$x 30, Net 45), etc. Variations of (x% 15, Net 30) means payment terms are 30 days, but if payment is settled within the first 15 days, [x%] discount on invoice value is given. [-$x] works the same way, just that it’s defined in value instead of percentage.
4. “High profit, low volume only“. Usually, the distributor will only accept credit terms for specific products. Limits the buyer from acquiring large volumes of products and minimizes distributor credit risks.
5. “Half and Half“, literally means selling fewer products to the retailer (or buyer).
6. Total cancelation of service.

Analyzing credit risks to potential defaulters should be handled by professional finance executives. This includes background search, database acquisition, monitor payment & purchase history, refresh credit checklist and so forth – To minimize defaulting risk and forecast possible defaulters. According to Pam Krank, president of Credit Department, an accounts-receivable consulting and outsourcing firm, says CFOs 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.” -CFO.com

Combating Credit’ing’ – Act like a bank

Extracted from CFO.com.

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.