Tips for Managing Credit: Published in LBM Journal


The big whale!

list of hard and soft costs of creditEveryone loves landing the big whale, that large customer who puts an upward kink in your sales and gets you buzz in the marketplace.  You worked hard cultivating that relationship and now they want to give you a try.  You ask your credit manager to set up their account and she comes back with a less-than-stellar report: Your prospective customer has a somewhat spotty credit record and chronically pays everyone slowly. 

Do you turn away the business?  You don't have to.

The key is to make integrated sales and credit decisions, not separate ones. Dealers know their 
cost of goods well and are often precision-like in understanding how to give price breaks and still make positive gross margin. However, most dealers ignore costs of credit and how those costs can vary widely by customer. 

Bill Lee, LBM industry veteran, reports that the fully-loaded cost of credit for most dealers is between 3.5% to 5% of sales.  If that number sounds surprising, it's because those costs are not contained on one line of your P&L but spread out across it. Costs of credit are not just the legal bills and bad debt on a small number of accounts but also the cost of money and cost to collect payment on all accounts. For dealers who have higher delinquencies or have contractors taking them out 60, 90 or 120 days, those costs can really add up.

So—if your large prospect pays everyone else slowly, how will they pay you? You got it. They’ll pay you slowly too. Knowing this, factor it into your pricing upfront.

Let’s use an example.

Say your average customer spends $100 and nets $25 in gross profit, or 25%. When you factor in warehouse, delivery, sales, administrative and financing expense, the net profit of the average customer is 4%. 

graph showing how slow payment impacts customer profitability

Let's also say you have a line of credit with a 6% interest rate annually, or 0.50% for every month. Someone who regularly pays you 60 days late is costing you 1% more in borrowing costs (2 extra months * 0.50%). That means this customer is occupying more of your credit manager's time by requiring check-ins and collections calls.  You are spending more time internally discussing this customer, and you and your sales reps are reaching out to check in on payment too, taking more valuable time away from growing your business.

The 80/20 rule generally applies here — 20% of your customers are occupying 80% of your time. The time lost isn't fake money — you are paying yourself, your sales reps, and your credit manager real money and this is where they will be spending some of it to the exclusion of other work. When you add it up, rather than having administrative and finance costs be 3% for the average customer, they're more like 9%.  Now you stand not to make 4% but actually lose 2%! 

Most dealers I know get wise after someone has strung them out and then try to fix this after that fact. Sometimes it works, sometimes it doesn't. It's just a lot harder to do. If you factor in what this whale is going to cost you including the higher cost of credit, make sure you price it accordingly. Celebrate the win and sleep well knowing your large new customer will also be a profitable one.

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