A friend of mine called to ask if it was possible to have no bad debt losses. My flippant response was: “Sure, if you don’t take any risk.”
Another friend of mine was fired after three years with no bad debt losses. Why? Because management said he was not taking enough risk. It is easy to limit risk if you limit sales to marginal or high risk customers and applicants for open account credit terms. However, there is a cost associated with this benefit.
If your credit granting criteria are set too tightly, you will turn away profitable business because of the possibility of slow pay or non-payment by one or more of these high risk accounts.
I told my friend that the role and the goal of the credit department is not to eliminate credit risk. Instead, it is to manage risks so that losses are contained and controlled. Of course, this is a lot more work than simply taking no risks and incurring no losses.
Why do most companies take these risks? The answer is simple: The companies do so because they are convinced that over the long-term the additional profits that will be generated on the open account sales made to marginal or high risk accounts will more than offset the bad debt losses that will be taken.
Here is the bottom line: I do not know of any well-managed, growing, profitable company that does not require their credit department to manage risk rather than avoid them. In my opinion, any company that routinely reports no bad debt losses is too conservative and is leaving profits on the table instead of in their pockets where they belong.
That’s my opinion, what are your thoughts?
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.