Banking & Finance Toolkit

Steve Foster,
Argos Risk LLC:
877.747.5411
sf*****@*******sk.com
www.argosrisk.com

Bruce Mallory,
Platinum Group:
952.829.5700
bruce.mallory
www.theplatinumgrp.com

Can your customers
pay you? How to
manage credit risk
In this rugged economy, far too many small-business owners aren’t getting paid what they’re owed, writes Steve Foster, the CEO and co-founder of Argos Risk LLC in St. Louis Park.

If you’re like most companies and offer credit to your customers, you’re acting as a bank and essentially making loans, but without the collateral, financial statements or personal guarantees, not to mention the credit-analysis skills, of a professional lender. That makes you an unsecured creditor, putting you at the bottom of the list of creditors. And that’s a big risk nobody needs, according to Foster.

All too often, small-business owners focus on selling their product or service – and forget the sale is incomplete until the cash is in hand. And nothing hurts more in business than working so hard to make the sale, but not getting paid for it.

But the risk of not getting paid is more manageable than you might think, Foster continues. On its face, it’s extremely simple: Get the right information about your customers to understand their financial standing, then act on the data to minimize your risk level. Foster provides these five steps to manage credit risk with your customers:

1. Take a microscope to your revenue cycle. Begin with investing time in getting your revenue cycle on track. Similar to using Lean and Six Sigma to improve the efficiency of a supply chain, scrutinize your revenue cycle. Eliminate any potential hiccups in the revenue process and tighten the time from the point you make the sale to the time you have cash in hand.

Start with targeting only the customers who can pay by creating a rigorous credit application (more on that below), then establish clear credit limits up front and clarify details in the purchase order to avoid questions and delays in payment later. Be sure to also make your invoice process speedy and specific, including moving from paper invoices to e-mail invoices that reach customers instantaneously, Foster writes.

2. Establish a tight credit application process. Next, develop an airtight, complete credit application process that includes signed bank and vendor references. Be diligent about who you extend credit to and how much. Base your decisions on the best information available. Remember that your best collection work is done before the sale.

3. Do your homework, continuously. Information is the key when it comes to monitoring credit risks, both before and after they become your customer. Use online tools to keep a close eye on potential credit risks. You can buy one-time reports, conduct your own research via Google and others, or get daily customer credit monitoring through a subscription-based service. Personal credit histories of company officers are also a good indicator of the company’s ability to pay. It pays to check out any court documents, bankruptcies, liens or judgments against a company, Foster advises.

4. Watch for warning signs. Avoid credit disasters by watching for – and acting on – the warning signs of increasing exposure to write-offs. Red flags include accounts receivable growing when sales are flat or declining, collection calls failing to yield payment, claims that invoices are “lost” or questioning the details to delay payment, payment only of smaller invoices, and internal reorganizations that delay payment.

5. Follow up with customers regarding payment – repeatedly. While good credit application screenings and monitoring are critical to reducing credit risk, if you see warning signs that a customer may be having financial problems, take prompt action. Increase follow-up to let them know your expectations for prompt payment. If it comes down to it, try to find win-win solutions such as collateralized notes before pursuing legal intervention, Foster writes.

No more ‘peaks and
valleys’: How to boost
predictable revenue

In this economy, many companies experience up-and-down revenue cycles – one good week followed by one bad week; one good month followed by one bad month, according to Bruce Mallory, a business adviser and managing partner of Platinum Group in the Twin Cities.

And the beat goes on due to seasonality, customer delays, vendor performance and a whole host of other reasons. Loss of a major customer can create more P&L “peaks and valleys.” Business owners under financial stress should carefully examine how sales efforts affect operations if they want to gain more opportunities for repeatable, predictable revenue. Mallory writes this advice for getting more dependable money in the bank:

The key to operations savings and new business growth is uncovering “baseline revenue” that comes from consistent customer patterns, Mallory writes. Many companies spend too much time to seek out, quote and win new projects – which may require more staff, training and equipment to complete. Instead, business owners need to focus on which customer types can generate a higher percentage of repetitive work to maintain baseline revenue.

For example, a company in the business of printing and mailing plastic cards has a major cruise line customer where every Monday morning the customer electronically transmits a list of passenger names and addresses to the company. From this information, the company efficiently produces and mails a letter and loyalty card to people who have returned from vacation. It is dependable revenue based on an automatic operation; minimal sales or customer service effort is required to maintain the customer and production staff is already trained to fulfill it, Mallory writes.

The challenge for this company is to land more business that is similar in nature and price it competitively, which means offering sales incentives to find this type of customer versus chasing and quoting on large, one-time project work.

Project work can be expensive and unpredictable. If 40 percent of business costs are pre-production – estimating, quoting, analysis, sales – and only five or 10 percent of quotes convert into sales, there is more wasted effort without commensurate return. This business model results in a peaks-and-valleys P&L, Mallory writes.

What’s more, if a job shop ramps up for different kinds of project work by hiring people or buying new equipment but cannot generate repeat business, then the ramp-down will cause either underutilization of people or unemployment costs. It is better to have a $1 million project spread out over a year versus the same project crammed into one month, according to Mallory.

To generate baseline revenue, owners should ask themselves: “What kinds of customers or clients generate repetitive work?” They need to define the ideal customer. It’s important to become aware of business patterns and consciously increase that percentage. Many small companies have only 10 percent predictable baseline revenue; a smooth operation would be 50 percent or more, advises Mallory.

To-do list

1. Analyze top customers. Understand where the majority of revenue is coming from. Go back several years to gain a historical view. Is this consistent business or one with spikes?

2. Price for predictability. Once customers are identified as either predictable or not, products and services should be priced to attract baseline revenue. This can be differentiated in the quote through volume pricing, blanket purchase orders and multi-year agreements.

3. Provide proactive customer support. Many companies wait for purchase orders to come in the door and customer service people wait for the phone to ring to handle complaints. Instead, train the customer service staff to work more proactively and less reactively with customers. A smoother sales-and-delivery cycle can be planned for mutual benefit through meetings, daily calls or blanket purchase orders. Put systems into place for initiating “customer care” contact, such as regularly scheduled weekly contact with customers via phone or e-mail

4. Gain “visibility” into customers’ forecasts. Vendor-managed inventory is a process that not only eliminates out of stock issues but also generates repetitive baseline revenue. All it takes is either online access to a customer’s inventory or a customer site visit to track inventory needs. The latter approach also can work well for service businesses.

5. Measure results more frequently. If reports are reviewed monthly, then go to a weekly basis; if weekly, then look at them daily. This will allow owners and managers to react more quickly to customers and even out the flow of production or service. For example, one manufacturer found that it shipped half of its business in the last five days of the month. With more organization and fewer errors, it now ships one machine every four days; this creates a regular “drumbeat” for employees to follow.

6. Grow wisely. If adding capacity with people or equipment, do it in parallel with baseline revenue; avoid the risk of adding capacity just to handle one big project.