It’s A Trap – Michael Dennis, CBF

It’s A Trap

I recently received an email from a credit manager friend of mine I will call Al.  The email explained that Al’s employer just hired a new CFO.  The CFO told Al that the company’s bad debt loss history was unacceptable and that something had to be done immediately.  Al suggested the following:

1.       Hold orders more frequently and more quickly on past due accounts

2.       Lower credit limits on marginal credit risks

3.       Refuse to grant open account terms to high risk applicants

4.       Require collateral or security from high risk customers and applicants

5.       Update credit files more frequently

6.       Attend industry credit group meetings more often

The CFO responded that these ideas would result in fewer sales and higher administrative costs.  She told Al to “think outside the box” and come up with better suggestions before their next meeting.

Al asked me for my suggestions.  I responded that his new boss was setting a trap.  Al was being given a task that he could not complete if for no other reason than this:  In order to reduce credit risk, you have to limit credit lines as well as hold orders on past due accounts.   This scenario reminds me of a story a friend of mine told me.  He was a pitcher and his coach walked out to the mound during a game and told him:  “Don’t throw anything this guy can hit, but whatever you do don’t walk the batter.

Michael Dennis, MBA, CBF, LCM

The truth is that everyone knows how to reduce credit risk, and the six suggestions listed above are a great start.  We know and the CFO should know there is always a trade off when a company tries to reduce credit risk.  Under similar circumstances, I have made this commitment to management:  I will guarantee lower credit risk and fewer write offs if you can guarantee to take the heat over lost sales opportunities.

That’s my opinion on this issue.  What’s yours?

Michael Dennis’ Covering Credit Commentary. Michael’s website is  www.coveringcredit.com

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.

5 Replies to “It’s A Trap – Michael Dennis, CBF”

  1. I agree. We take a very conservative stance on granting credit to customers. This has allowed our company fewer write offs. Personally, I don’t believe that setting risky credit scenarios with customers will benefit a company in the long run. At some point, there will be a loss and ultimately the gain could be wiped out completely. Tina

  2. Michael

    I agree with Tina. Her comment reminds me of something you once told me….

    One “Oh, Shi_” comment easily offsets 50 or more “Great Work” compliments.

  3. I agree with Michael that if the goal is to simply reduce write-offs then the steps he has outlined are the key.

    In regards to Tina’s comment, I would only agree if her company sells a product with a low margin.

    In general with a high margin product, you are able, and should be compelled to take additional risk. The higher the margin, the looser the standards can be. By limiting sales of very high margin product, you are adversely affecting the bottom line.

    On a lower margin, you must tighten your standards, as losses will more adversely affect the balance sheet.

    These are basic business credit principles.

    Respectfully,

    David First, CBA
    Shimano American Corp

  4. I think I agree and disagree with this. They taught me in law school to start every discussion with this comment!

    I agree because mitigating risk is very important in the credit world. It’s business credit 101. That is what a credit manager and a credit department does: they mitigate risk. They set credit policies and stick to them to avoid bad situations.

    Plus, if you look at the steps outlined in this blog article, they make sense, and they are correct, and they are very standard 1-2-3 steps to mitigate credit risk.

    I disagree, however, because we must also look at things from the perspective of the company. The company is not in the “mitigate risk” business. They are in the business of doing business. Which means sales, and revenue. So, what does a great credit manager have to do? They have to find a balance with this stuff.

    A week or two ago I wrote an article on my blog titled Three Traits Of A Great Credit Manager. My number two trait was “Great Credit Managers Are Interested In Taking More Business.” I state: “Great credit managers know that getting more business is job one, and they are constantly examining their policies and systems to see if there is a way to open the door to folks more often, and not less often.”

    But how?

    That’s the tough part. There are a number of ways:
    – Personal Guarantees
    – Letters of Credit
    – Joint Check Agreements (especially in construction industry)

    I particularly specialize in the construction industry, and preserving lien and bond claim rights is an excellent form of security. If you take advantage of this you are going to be able to take more business with less risk.

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