Sales War, the Conflict Between Sales and Credit
By: Abe WalkingBear Sanchez
Ninety-five percent or more of all Commercial or B2B Sales involve Credit Terms, payment due at a later date. The resulting A/R (short term money due from customers) is one of the largest assets of the business. The A/R is not only the greatest source of working capital for a business, but it’s management is also directly tied to the most profitable sales yet to happen, to the lowest of the low hanging fruit...additional sales to existing customers. And yet, in many if not most companies those engaged in Sales and those engaged in Credit and A/R Management are at odds with each other. The Credit Function is often referred to as “the place where sales go to die”, “the Sales Avoidance Department” and as one company CEO put it “the ugly step-child of Accounting”.
In this piece, I’ll cover the history of the old “risk avoidance at the expense of profit” mindset that still prevails, and that drives the conflict between Sales and Credit. This old thinking in turn leads to the use of credit performance measurements that have an adverse effect on sales and profitability. I’ll then address a new Profit Driven understanding of the Credit Function’s role based on the Profit Imperative. Once a new purpose is established, new sales friendly goals and new credit performance measurements will follow. Lastly, there will be a short quiz to establish your company’s current understanding of the Credit and A/R Function and a few suggestions for improvement.
Following the war, industry and the economy transitioned back to providing goods and services for the consumer. The 50s were a time of pent up demand and of growing demand as many women stayed in their new non-traditional jobs and as the population boomed.
The 50s were a time of Americans having money in the bank or in war bonds and a time of limited competition as many countries rebuilt following the destruction of the war. It was a time of a seller’s market with people standing in line, cash in hand, looking to buy things.
In the 50s, Credit was seen as a privilege, as a favor to some and not others. In such a business environment, the focus was rightly placed on avoiding the risk of customers failing to pay, and of incurring bad debt losses. DSO, average turn time on the A/R, and % bad debt are appropriate performance measurements when the goal is risk avoidance.
The shortages of the 50s are long gone. In today's world of rapid change, of mergers, of international companies competing for the same customers, of an increasing number of new business startups, of big box stores, of cyber competition and of quality/efficiency...
In order to compete, modern companies must have quality in their products and services and quality in the way they carry out business functions. A lack of quality will lead to increased cost of doing business for everyone involved in supply or production chain.
And yet, many if not most businesses engaged in B2B commerce still cling to the old risk avoidance mindset of the 50s at the expense of more sales and enhanced profitability. They still use DSO (day’s sales outstanding) and % bad debt to measure the performance of the business function involved in 95% or more of sales and with direct ties to the most profitable sales yet to happen...additional sales to existing customers.
The Profit Imperative...
While there are different ways of turning a profit, such as the Enron Model of books cooking, or of a company not paying its taxes or failing to fund the employees’ retirement plan. The best way of earning a profit, and the basis for what follows, is to meet or exceed expectations ...at a profit.
What is the investment made in the Credit and A/R Function and why is it made?
- The additional administrative costs of information gathering by Sales on new customers, of customer evaluation and customer credit performance investigation by Credit. Then there’s the cost of setting up the customer account and of billing.
- The cost of carrying A/R, the time value of money.
- The cost of bad debt should a customer fail to pay... a disclaimer, Not all bad is bad or equal, the seller’s Product Value at Time of Sale must be considered.
- It’s required... customers require that they be given time to ensure they got what they want and time to process the invoice for payment.
- The customer needs time to add value to the product or service purchased and to make sales to their own down-line customers.
- Credit terms are the norm and the competition extends credit terms and if credit terms are not extended a profitable sale is lost!
Credit is a lubricant of commerce that allows for the expanded movement of products and services.
Credit Approval is the front door. Given that the reason why credit terms are extended is to gain profitable sales that would otherwise be lost, the goal of Credit Approval is the find a way, via terms and conditions, to make a profitable sale happen.
There’s always a way to say yes to a profitable sale such as down payment requirements, shorter terms , PGs, Joint Pay Agreements, 3rd party guarantees, first born child. The goal of Credit Approval is to make a profitable deal happen.
A/R Management is the back door. If any kind of due diligence was followed during Credit Approval the vast majority of past due customers are not out to avoid payment...there are valid reasons why payment is not made by the date.
Collections is the enforcement of payment and is a relationship between a creditor and a debtor with the debtor being the beholding party. This is the old risk mindset at the expense of profit at work.
PDCM is the completion of the sale. It’s the process of listening to customers to determine why payment was not made by the due date and then resolving the issues or issuing a credit if called for and having the payment made and the customer reordering.
The goal of the completion of the sale is dealing with issues so that payment is made and the customer keeps buying. Because of the risk factor involved with the very smallest % of past dues that represent a potential for loss there’s a secondary goal of identifying early on those customers who are uncooperative, lie, break arrangements and who given time will skip out ...so that losses can be controlled .
Remember that the A/R is the greatest source of Working Capital…and that its management is directly tied to the most profitable sales yet to happen...additional sales to existing customers.
Profit Performance Measurements...
“The path of least resistance is the path of the loser.” HG Wells
The goal of credit approval is to maximize profitable sales, and that being the case we want to measure for the Percent of Applied for Dollars Approved. A profit focused credit function should be saying yes to more than 100% of the applied for dollars. They should never think of setting credit limits, limits on profitable sales, but rather on establishing expanding credit lines. Remember there’s always a way to say yes.
The goals of PDCM - the Completion of the Sale - is to keep customers paying and buying and the early identification of the very smallest % of past dues that are at risk of failing to pay and controlling losses. Based on the goals for PDCM (Past Due Customer Management) we want to measure for the A/R percentage under 60 days and for how soon a potential loss was identified and controlled.
Just as with Sales, Credit Sales is not a black and white accounting function, so when looking at performance measurement results the question to keep in mind is WHY?
The Promised Quiz
- What % of your sales involves credit terms?
- Your Accounts Receivable (short term money due from customers) makes up what % of your total assets?
- In your company who does the Credit Function report to?
- How is the performance of your Credit Function measured?
- Based on your new understanding of the Credit Sales Approval and PDCM (the completion of the Sale) function consider if the right people are involved. First and foremost these people must be able to establish and maintain relationships ...they must be communicators.
- Replace traditional Applications for Credit with a New Customer Information Form ...to be completed by Sales.
- Have the A/R Aging printed/sorted by largest dollar account balance and work the largest past due dollar accounts first…the 80/20 rule.
- You can’t go wrong by meeting or exceeding expectations...at a profit.
- The thinking that Credit Management is about risk avoidance and that it’s a cost center, a necessary evil and the ugly step child of accounting.
Copyrighted 2014 by A/R Management Group, Inc. All Rights Reserved
Canon City Colorado, USA