What Are Your True Costs of Providing In-House Credit?

February 9, 2017 Scott Simpson

Many building material dealers do not know the true costs of providing in-house credit. They may know the interest rate they charge after 30, 60 and 90 days, but they haven’t allocated all attributable expenses to each customer account, which would reveal the true combined costs of credit extended to a customer.  Why the need for such precision? Perhaps in higher-margin business sectors, outside of building material distribution, there is more room for averaging customer costs.  But in our sector, where margins are only 4%-5% and the cost of credit over an economic cycle is 2-4%, managing credit well has a meaningful impact on the bottom line. There isn’t room for not knowing true costs at a granular level. 

The reason why dealers don’t know the true cost of credit is simple: They often don't know how to calculate it or they may be in denial about exactly how much the cost of in-house credit is dinging their bottom line. Moreover, those costs can change dramatically depending on the economic environment. If you ask a dealer about the true costs of granting in-house credit, he will likely talk about those costs in a good year, when there are actually two additional types of years to consider: 1) bad years and 2) average years. All three must be examined for an accurate picture of your business over time. When you engage in this exercise, you will notice that some costs rise in a recession, even as revenues fall.

What costs could possibly rise?  First let’s list a series of typical financial line items, and let’s assume some proportionate baseline numbers for a company whose profile is $10 million in sales, 48 DSO (days sales outstanding), and 0.5% bad debt (see Fig 1).  With this in mind, we can compare a good year to a bad one, and see each type of year in the light of an economic cycle average.

Fig 1.

First, note the numbers that don’t change, whether it’s a good year, a bad year, or an average year: 1) The costs of billing, bureau, and credit scoring, 2) the cost of labor, and 3) the cost of management. Now, let’s look at the costs that do change in a recession, and compare it to a good year and an average year. 

Interested in reading the full article?  Check out: What Are Your True Costs of Providing In-House Credit?

About the Author

Scott Simpson

Scott is president and CEO of BlueTarp. He has spent the majority of his twenty year career in financial services helping businesses grow more rapidly through the effective use of credit.

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