Streetwise Credit And Collections

Maximize Your Collections Process to Improve Your Profitability

Suzanne Caplan

• Publisher: Adams Media
• Year: 2006
• Print ISBN: 9781593377373
• eBook ISBN: 9781440517242
• Topic: Business
• Subtopic: Business General
• Index: Business

The credit and collection function of any business is the nerve center of the company. If proper records aren't kept and receivables closely monitored, a company will have difficulty maintaining its cash flow and operations. Streetwise Credit and Collections provides you with the skills to manage your company's financial obligations, collect due payments, and avoid falling into debt.

Streetwise Credit and Collections includes complete state-by-state requirements for small claims court, and sections on the applicable laws, statute of limitations, and legal interest rates that may be charged. The appendices contain information necessary for all businesses that grant credit, including the Equal Credit Opportunity Act and the Fair Debt Collection Practices act.

Includes advice on:

• Securing credit and granting it
• Setting credit policies for your customers
• Hiring a collections agency as necessary

You will undoubtedly encounter credit and collection issues from time to time. With Streetwise Credit and Collections, you'll have the information and advice to make the best business decisions and keep your cash flow healthy.

1
Why Credit
Is a Business
Necessity

Part one
Part two
Part three
Part four
Part five

Chapter 1 How Credit Creates Leverage

Chapter 2 Securing Credit from Vendors

Chapter 3 Providing Credit to Business Customers

Chapter 4 Credit Takes You Global

Chapter 5 Providing Credit to Consumers

The Leverage to Start a Business

In the operation of your business, you will be not only a grantor of credit but a seeker of outside sources of capital and, it is hoped, a recipient of credit. We usually associate the obtaining of loans with banking institutions, but it is important to realize that receiving credit from vendors is also a form of loan to your company. And because banks are actually in the business of granting credit, they can serve as good models for learning the basics of how to judge the ability of a customer to pay.

Building a growing business requires capital at the outset, even before there are any meaningful revenues coming in. Often this money comes from the owner’s investment, but any business that seeks significant growth will require outside sources of credit. This means that the assets you have purchased can be leveraged in order to fund additional growth, from inventory to wages. “Leverage” means that you use future revenue to secure current needs.

The best example of this type of financing is with the purchase of real property, whether in the form of a personal residence or a business building. You leverage your current cash and future earnings to make a purchase for current use.

Understanding Leverage Ratios

As a business owner in the position of seeking credit, you do not want to borrow more than you can pay back over time (assuming that your profits and cash flow will meet projections). And as a credit grantor to your own customers, you do not want to allow them to get in over their heads, in terms of running up debt that they will not be able to pay back over the next few months or years. Credit problems spring up more often from an inability to pay than from any unwillingness to do so. Using existing collateral to borrow cash is permissible but if the leverage (the debt to equity) is too high, the earned cash flow will not be sufficient to retire debt within its terms. When assets are inventory or material that will be sold, the leverage can be higher than with assets such as equipment or buildings.

Cash Is a Timing Issue

Cash flows through a business on a continuing basis, although there are times and circumstances when the outflow exceeds the inflow. In a new venture, the expense of asset purchases will not be immediately returned by way of cash income. Instead, the funding for your business will likely take the form of owner investment or long-term borrowing from a bank.

You will pay back this principal from future profits.

The other challenge your company may face is from the depletion of capital due to a period of operating losses. This type of situation is unlikely to be remedied by any borrowing of funds, since banks will not fund a loan to cover losses. The cash will have to come from outside investment or from the sale of any unneeded assets. The better prepared you are for the cash flows in and out of a business, the better you will be able to meet the credit needs of serving your customers.

In circumstances in which your business cash is invested in inventory, in work in process, or in accounts receivable acquired as a result of sales, the resulting imbalance of funds may reasonably be replaced by bank lending. As the cash begins to flow in, the loans are paid down or can be paid off entirely. Bank funds are then used over the short-term to smooth out the timing of cash inflow. Such borrowing is usually through a line of credit that can be drawn on as needed.

Retaining Profits May Rebalanced Cash

When your company has a prolonged period of profits that creates a positive cash flow, it is usually good policy to keep the cash in a money-market account that is readily accessible. Often the first instinct of business owners is to increase the salaries or draws for themselves and perhaps other managers, or to purchase some expensive new equipment. But being conservative with expenses in order to build a cash cushion is sounder business practice. If the new equipment is necessary and will offer a payback over time, consider going to your bank for a loan to facilitate the investment while conserving your internal cash to carry you through possible slow times. A business out of cash is a business out of choices. Overspending is a behavior to watch out for in your customers as well. Customers who are spending lavishly may be using up all of their cash reserves.

Turning Assets into Collateral

Many seasonal businesses build inventory prior to their big selling season. They may buy material over a period of months and try to pay for it when the bills come due, even if that is long before any goods are sold. This practice usually strains the cash flow of your business. Instead the inventory (assuming that it is current and will be sold) can be used as collateral for a loan.

Your growing accounts receivable are also assets that may be used as collateral to secure a loan. All of your noncash items that will convert to cash within six months are eligible. This type of short-term borrowing is undertaken to add cash funding to cover slow times. As inventory is liquidated and customers pay their bills, you will be able to retire your loan. Most banks are willing to make short-term loans where there is a reliable likelihood of early payback.

Only Current Accounts Receivables Are Eligible

Most lenders will require a current aging of your receivables (a chart of what debts are 30, 60, 90 and more than 90 days out) to determine the value of your collateral available to support a loan. Some will verify the credit worthiness of your customers as one of the criteria for the loan limit they are willing to advance. If a big customer becomes a credit problem to you, you are likely to become one to the bank. Train yourself to collect receivables promptly from your customers.

The other issue a lender will consider is the date of your customer invoices. Any charge that is over sixty days old (and assumed to be thirty days past due) will not be eligible as loan collateral. Typically, neither will any other outstanding or future sales to delinquent customers. This policy should be instructional for you since if sixty days have passed without your being paid for goods or services, there is an increased risk you won’t be paid. Banks apply these rules, and you should do so as well. You want the next sale but not if the previous one has yet to be paid for.

Using Other People’s Money (OPM) to Make Money

A profitable business seeking to grow a larger venture will have a need for cash from outside sources to leverage its concept or skills. In addition to working with traditional lenders, you can negotiate to partner with your vendors for extended terms of payment, which as mentioned earlier is really another form of receiving a loan. As money comes in that you would typically use to pay a vendor’s bills, you can—with the vendor’s approval—use your capital to continue building inventory in order to increase your future sales. And in turn you can increase your purchases from that vendor as a result of its forbearance.

This strategy works better for a retail or wholesale distribution company whose cash is tied up in short-term investment, that is, in selling products that will be turned back into cash in a reasonable period of time, usually less than sixty to ninety days. Consider the shelf life of your product if you are thinking about asking a vendor for extended terms. Money owed on obsolete inventory is unlikely to be paid.

OPM = Outside Investors

When the need for capital is for purposes of longer-term investment (such as in equipment or technology development), the source to use may be an outside investor who is willing to put capital at risk for the possibility of high return. Bank loans and lines of credit are, according to their stated terms, obligations that must be retired. Investment in a business, on the other hand, is not guaranteed. Rather, an expectation of payoff may be tied to future profitability or to an exit strategy (such as a public offering or sale of the company). This ability to leverage resources is necessary for any business with an aggressive growth plan. The difference between a business investment and a loan is that the former is at risk and the latter is secured by collateral or a promise to pay regardless of outcome.

Your Bank as a Source of Credit

Most banks offer a variety of loan products and credit services that you can use to fund your business. In addition to (typically) longer-term secured loans and shorter-term lines of credit, you may also be able to secure a bank-issued credit card that enables you to make small purchases or fund travel and entertainment expenses; you can then choose to pay the bill in full each month or over time. Careful use of such additional capital can assist your cash flow as well. Remember, however, that the cost of this type of credit is higher than that of most others.

Your Bank May Provide Credit Processing

Most banks are looking for business customers who will take advantage of various se...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Acknowledgments
• Introduction
• Part One: Why Credit Is a Business Necessity
• Part Two: An Effective Credit Policy
• Part Three: Putting Policy into Practice
• Part Four: Aggressive Collections
• Part Five: The Art of Credit
• Epilogue
• Appendixes