Four ways to improve your credit program and boost cash flow

August 24, 2015 Scott Simpson

as seen in Lumber Cooperator

We’re all optimistic about the signs of growth in the LBM industry. One recent report states that the seasonally adjusted annual rate of new home production has topped one million for the first time since 2007. Building supply dealers are focused on stabilizing and growing their businesses, but have painful memories of cuts to staff, services, and inventory. Now is the time to understand the lessons learned from the past and make simple changes that will keep cash flow flush and credit risk low.

Being great at credit is a key factor in healthy cash flow and the ability to invest in those things that grow sales. It keeps accounts receivable (AR) from building up, keeps banks happy, and
the time and the cash flow to focus credit where it’s most valuable—growing business.

On the flip side, slow pay by your customers means cash flow is tied up in AR, creating a  significant barrier to your ability to buy inventory, increase delivery, hire sales reps, or similar investments that helps grow sales.

Below are four simple ways to improve your credit program and avoid repeating the mistakes of the past:

Invest the Time to Understand How Your Bank Views Your Business

Your line of credit is the oxygen your business requires in order to function. Spend time getting to know your banker and make sure they understand your business. When the bank structured
the deal, did they take into account the unique aspects of your business? If you have a bump in a covenant, can you trust the bank will not take a hard position and call the loan?

Building a strong relationship with your bank is an ongoing process, and your ability to gain their confidence is essential. This takes work, not only at the time of deal negotiation but also post-deal, with frequent and proactive communication about your ongoing successes and challenges. This sets the groundwork to ensure reasonable and rational discussions when you need some help or when you are asking for improvements in your deal.

Every bank deal is unique, but there are a lot of commonalities. Banks are in the business of making sure they are protecting their principal, so they get concerned when anything threatens that. Many dealers have relationships with their banks that are friendly and tight, but loan officers are trying to avoid downside risk and are monitoring for any tripped covenant.

Often covenants are about operating income—the percent of your AR that is delinquent, a certain amount of losses that you’ve experienced, or the kind of liquidity you have. The more losses you incur implies higher volatility for them. Banks get skittish when they see too much delinquency and write-offs. If you’ve tripped a covenant, they have rights to charge you more interest for your money, reduce your credit line, or even remove it. This is like taking the oxygen away from a fire;
it can kill your business.

Set Clear Credit Limits

If you haven’t explicitly set clear limits, then you really don’t have any.

There is a continuum of how tight and or loose credit programs can be. On one end is what we call “the sales prevention team,” a credit team that is so tight that your sales reps complain
that no one can get approved. On the other end, you have the open door, where no one effectively gets screened out. Most people would agree that neither extreme is healthy.

You do need to know upfront what situations will garner a “no” response from your bank. How large is too large a line? Below what credit score an application is declined? What your approach will be if you require a personal guarantee and someone declines to provide you one or they provide you a bad one?

Know How to Screen for All Major Risks, Not Just Bad Debt

Now that you’ve set clear limits and have shared them with your credit and sales teams, it’s time to assess how well you can screen for all major risks.

Dealers today need to beware of contractors who went out of business and are coming back. They may have burned you before and now they’re asking for a new credit line. The key is
to have powerful screens for all types of risks, not just bad debt. Most dealers with which we engage tend to focus only on whether they’ll get paid or not. It’s key to know that there are many
tools available that allow you to assess various risks.

When someone is asking for credit, you should be evaluating four different risks. Two of these, bankruptcy and fraud, you should be screening out. The other two, their likelihood to dispute
and the probability of them paying you slowly, are risks that can be mitigated
if you understand them upfront. The question is: How do you evaluate these risks? Invest your time and some money to have the right tools to manage these four types of risk.

Bankruptcy risk: Make sure you are pulling from commercial credit bureaus in addition to consumer credit bureaus. Also, collect personal guarantees and make sure they are from prime or super prime credit quality customers.

Slow pay: How contractors pay others is a great indicator of how they are going to pay you, so look at the percent of trades that are in the credit bureau file that are 60-plus and 90-plus days past due. You can also gain insight by understanding where they stand in the payment hierarchy. If they are getting paid last, it’s likely you are getting paid last, too.

Disputes: When calling their references, don’t just ask about payment history, but ask how often they’ve had issues or complaints from this contractor. And check BBB for what this contractor’s customers are saying about them.

Fraud: Beware of the perfectly filled-in application and the prompt reference call returns. Ironically enough, that’s a signal that something may not be right. Use Google maps to verify their business address. We find some people have not taken the time to verify their business address.

Make Integrated Credit and Sales Decisions

If they have made it through your screening and you decide to issue credit, make sure it’s an integrated sales and credit decision. The most impactful decision comes down to how you price to ensure that a paying customer is actually a profitable one too.

Most dealers know their cost of goods sold very well, but often ignore other factors that are keys to profitability. A big one is understanding your true cost of credit. Veteran LBM consultant Bill Lee estimates that the fully-loaded cost of credit ranges from 3.5% to 5% of sales. The real
key behind that is the often-ignored costs—the cost of money and the cost to collect. For dealers who have higher delinquency, or have contractors taking them out 60, 90, or 120 days, those
costs can add up.

If you know your true cost of credit, you can better understand what a slow payer is going to do to your profitability. If someone is going to regularly take you out to 60 or 90 days, they’re effectively hiking up your administrative costs (the cost to bill, the cost of collections, etc.) and line of credit costs (the borrowing).

So what do you do with the large customer that pays everyone else slowly and is asking for a credit account? Do you decline them and lose the business? Not necessarily.

An integrated sales and credit decision is about pricing for this kind of situation upfront so that your sales team and credit team are on the same page. Most dealers get wise after someone
has strung them out and they try to fix this after the fact. Sometimes it works, and sometimes it doesn’t. By assessing the situation early, you can offer a price to the customer that accounts
for the fact that they are going to slow pay.

You should also think about factoring in which accounts cost more for delivery (distance, number of drops), more sales time, or other special asks. Often these are very large customers.
Sometimes you might find your very large customers spend a lot, but make you nothing in the end once all the added costs are factored in.

Making these four improvements to your credit program can be game changing. They are likely to result in predictable, faster cash flow, protection from credit risk, and the security of
your bank line.

Ultimately, it’s not about spending a lot of time and cash on credit. It’s about making sure that your time and your cash can be invested in those things that will grow your business.

There are four simple ways to improve your cash flow so you can invest in those things that grow sales.

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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