Don’t Get Stuck Between a Rock and a Hard Place – Michael Dennis, CBF

Don't Get Stuck

Sooner or later, every credit professional will be asked this question by their boss: “What credit limit do you recommend we assign to this customer or applicant — the one with the deficit net worth?”

Customers with a deficit net worth are technically insolvent, and insolvent companies have a nasty habit of filing for bankruptcy protection. There is no good or right answer to this question. The answer depends on your company’s tolerance for credit risk. However, the fact that your manager is asking you for a recommendation suggests that s/he believes the customer should be given open account terms at some dollar level.

I use one of two approaches to address this problem. The first involves rephrasing the question this way: “If you are asking how much credit I would extend to a company that is technically bankrupt, the answer is that I would not recommend open account terms.” This response is honest and direct, and makes your position crystal clear.

The other approach involves explaining that your experience does not provide you with any guidelines relating to recommending credit limits for customers with a deficit net worth, and that you would appreciate their help. Ask for their guidance about what process they would use to determine how much money your company is willing to risk on this type of customer. Done correctly, this can become a useful training tool for the credit decision-maker.

Both approaches might cause your manager to question your willingness to make tough decisions. The good news is that you may be able to avoid the problem altogether by updating your Policies and Procedures Manual. If you develop a Credit Policy that addresses who has the authority to extend credit to the highest risk companies, and what facts and factors that credit decision will be based on, you can avoid being caught between a rock and a hard place.

Michael Dennis, CBF

I am always interested in hearing your opinions. Please let me know how you have handled this challenge effectively.

Michael Dennis’ Covering Credit Commentary. Michael’s website is

The opinions presented are those of the author.  The opinions and recommendations do not necessarily reflect the views of CMA, or their Officers and Directors.  Readers are encouraged to evaluate any suggestions or recommendations made, and accept and adopt only those concepts that make sense to them.

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6 Replies to “Don’t Get Stuck Between a Rock and a Hard Place – Michael Dennis, CBF”

  1. Dennis, Typically I tend to agree with you but in this case I feel you have missed a bit. Unless you are new to the organization, you should already know what your organizations appitite is for credit risk. You should already know if the company is willing to sell to technically bankrupt customers and how they intend to secure their risk. If you are walking into a company that does not have the policies and procedures already documented, then they hired you because of your expertise and you should be the individual who guides the company in the direction they need to go to limit their risk but expand their sales in as secure a position as possible. Identify what the benefits of selling are against the risk and then make your decision based ont hese facts.

  2. Generally, I view credit as a “balance wheel”, giving the conservative viewpoint which balances Sales’ desires. Lately, most salespeople I know, in and out of my company, are becoming more conservative in the arena of risk.

    When I’ve been confronted with a situation like this before, I give my honest viewpoint, that extending credit to an essentially bankrupt firm is a recipe for disaster. If senior management really wants the customer to be opened, I ask the individual responsible to sign off on an exception, either in the file or by e-mail (which I then add to the file), so that when and if the account goes off the rails, the reason for extending credit is laid at the feet of the person making the decision, along with the reasoning by Credit against that decision.

    This is a valuable training tool for senior management, too, since they begin to understand that the recommendations of Credit are based on experience and metrics that will usually predict a customer’s actions, and not just on opinion or suspicion.

  3. Judy

    Thank you for your comments. To me, this question is as difficult to answer as this one — Do you still cheat every year on your Income Taxes.

    In my opinion, this is not a decision the credit department should be making. If senior management wants to provide guidance about how much they are willing to risk on this type of high risk account, I will (a) input the approved credit limit (b) monitor the account’s risk profile carefully for further deterioration and (c) do my best to collect balances owed as the become due.

    My real goal was to suggest that credit professionals are asking for trouble when they start making business decisions rather than credit decisions that involve establishing appropriate credit limits using time tested techniques. If I failed to achieve this goal, I will try to do better next time.

    As you know, any scenario in which a customer has a deficit net worth is exceptionally high risk. I have explained the risk to salespeople many times using this analogy:

    Assume that you are a bank lending officer. I walk in and ask about a second mortgage on my house. When asked, I tell you my house is worth $300,000 and I owe $350,000 on the first mortgage — meaning I have negative equity of $50,000. How much would you loan me?

    I really appreciate your feedback, and the opportunity to clarify this.

  4. Michael,

    I thought I would be the first to respond, but I guess not. I think the solution to this problem, as Judy suggests and you mentioned, is to know and to formalize the process for dealing with credit applicants and customers that are exceptionally high risk.

    At one company I am familiar with, this issue was addressed in the Credit Manual that indicated who had authority to approve credit limits for customers with deficit net worth — and it was not the credit manager. However, the credit manager was expected and required to propose a credit limit for review and approval.

    I think this approach addresses your concerns and Judy’s comments.

  5. Everyone has made some valid point here. Michael, I agree with Judy that a credit professional needs to know his or her company’s policy regarding extending credit to “insolvent” companies. Michael Dennis, I agree with you that credit managers should not be making these high risk decisions without sign-off by senior management. Michael Zininberger, I agree with your suggestion or solution to this dilemma.

    I read this somewhere… This is a subject about which reasonable and intelligent people can have legitimate differences of opinion.

    Let’s keep the dialogue going 🙂

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