If you grant credit to retail or commercial customers and don’t have a credit manager, you may be losing money without even knowing it’s happening.
Take a hard look at your accounts receivable aging and listing. How many customers are actually paying you on time? How are you making credit-limit decisions? Has your company written off any bad debts in the past few years?
If you are in the wholesale business, it’s extremely likely that your company’s largest asset is accounts receivable. Now, who do you leave in charge of that asset? A minimum wage office employee with little or no credit training?
If so, it’s time to bite the bullet and hire a professional credit manager. “But,” you say,“this person will cost me $35,000 to $60,000 per year!” Yes, it will. But if your manager is good, he or she will earn their salary plus add additional dollars to your bottom line by collecting your receivables more quickly.The hidden cost of receivables is the bank interest a company pays when they borrow to fund the difference between supplier terms and customer payments.
For instance, John Doe Oil Company (JDO) has sales of $15 million per year. John Doe has his faithful office worker, Jane, in charge of his accounts receivable. She doesn’t like asking people for money and avoids conflict whenever possible. Therefore, when customers are a little late, she sends out a late notice so she won’t have to confront them with a telephone call.
With Jane in charge of collections, JDO collects receivables on average in 26 days. Jane thinks that’s pretty good. She remembers her bookkeeping class where they told her any collection time under 30 days was good. JDO, like most businesses, has cash flow crunches and usually borrows money on a line of credit from their bank. The borrowing rate is currently 10.5%.
John Doe looked at hiring a credit manager once, but the only person he could find for the job wanted about $20 per hour. John figures he’s pretty smart saving the extra $6 per hour, or $12,480 per year. But is he? Let’s see what Jane’s inexperience is actually costing. At $15,000,000 annual sales per year, each day of sales is $41,096 ($15MM/365). JDO’s customer terms are 15 days with some larger fuel accounts on shorter terms.
Looking at Jane’s 26-day collection results, we see that Jane collects 10 days slower than the industry average of 16 days. At $41,096 receivables per day times 10 days, JDO has $410,960 more accounts receivable than the average marketer. Since JDO is required to pay for fuel in 10 days, the company ends up borrowing this $410,960 on their line of credit. At 10.5% interest, Jane is costing JDO $43,151 in interest per year! So, to save a little over $12K in salary cost, John Doe is sacrificing $43K in income paid in interest payments to his bank! John is not looking quite so clever.
To find out if your receivables person is costing your company precious income and cash, check your results against the industry:
- Determine your average sales per day.
- Divide your accounts receivable balance by your average sales per day.
- Compare your collection time to the table above. (Never be satisfied with less than the mid 50% results and shoot for the top 25% if your terms allow it.)
- Subtract the industry average days from your own actual collection time.
- Multiply the difference in days from the previous step by your average sales per day. This is the extra amount of receivables you are carrying on your books.
- Multiply these extra receivables by your working capital line interest rate. This is the true cost of your receivable slowness.
If this is not enough to convince you, then look at your bad debt. What is your company’s total bad debt for the past three years? Would a sharp credit person have let all that bad debt occur? Likely not. Although even good credit managers get occasionally snagged by a bad account, they usually make a major dent in annual write-offs.
If you want to take a no-risk look at what a credit manager could do for your company, consider a temporary employee. You can hire a temporary credit manager to see what impact he or she could have on your business. This is a no-risk way of testing the “fit” of a new personality in your office. Temp agencies will gladly substitute workers until you find just the right person. To be fair, give the credit manager a 180-day trial, particularly if you’ve never had a credit professional on staff before. He or she will need time to go through your files and get to know your customers.
When interviewing, require prior experience with your customer’s industry. For instance, if your biggest customers are contractors, make sure the applicant knows how to analyze contractors’ financial statements in order to make a credit decision.
Local trade contacts also are important. A credit manager who is well-connected to the local community is far preferable to the person that just moved to town. Professional training is also a plus. Look for applicants who are members of the National Association of Credit Managers.
A good credit manager should not cost you a cent, but should save you money you’re now silently throwing away on bank interest and bad debt.
