Sales and Cash Flow Enhancement A Profit Center Waiting to Happen

By: Abe WalkingBear Sanchez
Copyright 2004 A/R Management Group, Inc. www.armg-usa.com All Rights Reserved.

Whether yours is a small or large business you can improve on profitability by rethinking the role of credit and A/R management.


Ask how they think of their credit and past due A/R management function and most business people will respond with a negative. One company CEO referred to it as "the ugly stepchild of accounting", others think of it as a cost center, the sales avoidance department, the stressful job balancing sales and losses, and of course as a necessary evil.

The Purpose of Credit

Every business function should have a clearly stated purpose which answers the question, "Why incur the costs associated with the function?" The stated purpose must also support the overall business strategy.

The costs that go with extending credit terms to customers start with the gathering of information on "who" the customer is and "how" they do business. This should be done by the sales people so as to avoid the redundancy of the credit people having to re-contact the customer and driving up the costs for creditor and customer alike. The information gathered is then normally forwarded to the credit people for credit checking, evaluation and approval. If approved an account is established and invoices and perhaps statements are sent. If a customer fails to pay within terms they must be contacted. The costs that go with these actions would not exist except for credit being extended and can be lumped under an "additional administrative costs" heading. Once a credit sale is billed we create the cost of carrying A/R (the time value of money). And then of course there the bad debt cost should a customer fail to pay.

Why Extend Credit?

If credit customers require that they be given time to ensure that in fact they got what they wanted, and they require time to process the billing; credit terms must be extended or a profitable sale is lost.

If credit customers require time to add value to purchased products/services and to make sales to their own down line customers; credit terms must be extended or a profitable sale is lost.

If the creditor/seller has competition that offers credit terms so must they to avoid loss of a profitable sale.

Credit is "the selling of a product/service based on payment at a later date", it is a lubricant of commerce that allows for the expanded movement of products/services. Credit is a function of sales and yet most often it is thought of as an accounting function and is driven by "risk management" thinking.

The goal of credit approval should be to find ways to say "yes" to profitable sales while remaining confident of payment; to do otherwise is a waste of the investment made in getting customers to the point where they want to buy and risks alienating them. No one likes to be rejected and when they are they remember.

Completion of The Sale

Survey after survey has found that while on average 25% of A/R (short term money due from the sale of a product/service) are 1 day plus past due, less than 1% are ever written off as a loss. The vast majority of past due customers can and will pay; they are not trying to avoid paying. The management of these past due accounts is not "the enforcement of payment", that’s what collection agents and attorneys do, it is the "completion of the sale". The primary goal of past due A/R management is to keep credit customers current and in a position to buy again and again. The most profitable sale is the repeat sale to an established customer. The secondary goal is the early identification and control of the small percentage of past dues that represent a potential for loss. A/R is often one of if not the largest asset a business has and keeping credit customers current results in good positive cash flow.

Be Careful What You Ask For

A publishing company was suffering from a serious cash flow problem due to the number of A/R 90 days plus past due. Its bank refused to advance/loan any money on these accounts and the investors were talking about pulling out of the business and closing the doors. Rather than fire his credit manager for allowing the situation to develop the CEO came up with an idea for improving cash flow; he’d pay the credit manager a 3% bonus on all 90 day plus accounts collected.

At first the scheme seemed to work as the number of 90 day plus accounts dropped and cash flow improved, and then the number of accounts reaching 90 days went up and cash flow slowed. Based on the 3% bonus the credit manager wouldn’t contact past due customers until they hit 90 days past due. The bonus was great for the credit manager but it just about buried the company.

In very much the same way, use of the traditional credit measurements of DSO (days sales outstanding) and % bad debt are counterproductive for they are measurements of risk. Credit managers focused on "risk management" will look for ways to "qualify" new credit customers and to place existing credit customers on "credit hold".

In Summary

The use of DSO as a cash flow indicator is fine although CDI (collection days index) is better, but as a performance measurement it misses the point. The percentage that fail to pay is worth knowing but it shouldn’t define the role of credit.

The only reason for any business to incur the costs associated with extending credit is in order to get a profitable sale that would otherwise be lost. Credit approval should be sales and profit driven.

Businesses should not engage in collections, in forcing debtors to pay; unless of course they are collection agents or attorneys. Past due A/R management should focus on keeping customers current and on controlling losses. In many businesses the true potential of the credit and A/R management function has yet to be realized, it’s like a profit center waiting to happen.