The collapse of Fannie Mae, Lehman Brothers and other significant financial institutions in the U.S. has been attributed primarily to the sub-prime mortgages that the banks were so eager to provide the American public. As devastating to the institutions (and the economy) as these bad loans have been, the devastation is not unlike that felt by any small business when it is hit by bad loans. The scale is different no doubt (just add a handful of zeros), but the impact can be just as punishing.
The business loans of which I am speaking are those created every time you extend credit to your customers, and the devastation is experienced when you incur a sizeable bad debt.
Called “Bad” for a Reason
Some people fall into the trap of underestimating the impact of a bad debt. In my experience it has not been uncommon, for example, to hear a sales rep say they can make up a $25K bad debt with a new $25K order. A loss of a $25K customer is not the same as the loss of a $25K receivable. The former affects the top line, while the latter goes direct to the bottom line.
If your pretax income is 10%, then the loss of a $25K receivable is the same as the loss of a $250K customer. If your pre-tax profit is less than 10%, then the corresponding sales equivalent is even higher.
So, given the significance of bad debts, what can we do to avoid them? Well, it is useful first to distinguish the two principal causes of uncollectible accounts.
Two Types of Bad Debts
Classified by their root cause, bad debts can be the result of either operational issues or credit granting issues. Operational issues include uncollectible accounts that arise from one or more of the following:
Poor quality jobs
Late delivered jobs
Mishandled deliveries
Poorly specified jobs (not understanding your client requirements)
I won’t go into how to avoid this type of bad debt, as the solutions should be self-evident.
Credit granting issues, on the other hand, are those where you extend credit where it should not be granted. Don’t let the urge to “make the sale” take precedence over the exercising of good credit checking and credit granting procedures.
And what are we looking for when we check credit? In particular you should be looking to identify customers who are:
Shady, (those with history of shirking their payment responsibility)
Undercapitalized (perhaps well-intentioned, but relying on a future event to pay you)
There are organizations such as D&B and Equifax that can help you with this assessment, and certainly you should subscribe to some such service. If you do, make sure you are making reference to their listings of law suits and returned cheques and not just their summary reports. Scanning of these types of listings on a regular basis can alert you to changes in your existing customers. Unfortunately, the activity of many smaller customers can elude the eye of these organizations, so prudence dictates that you check references carefully.
Checking customer-supplied references can be helpful, but bear in mind who is providing you with the reference! If you don’t know the supplied reference personally, or by reputation, you should carefully consider how much stock to put in what they tell you. Unfortunately, it’s not unheard of for supplied references to be in cahoots with a shady customer. In fact, more than one printer was conned in this past year by a particular customer employing this technique, and the losses were very significant.
When checking references, always insist on talking with a previous printer. Customers will generally pay their core suppliers, but you want to know how they pay their print suppliers. Try to develop a group of printer friends that you can informally touch base with about customers that you are not sure about. I know that it is tough to talk to your competition, but sharing stories about who has burned you can save you heartache and strengthen the whole industry.
If you are considering dealing with a new customer where you are not comfortable with providing credit, then don’t provide it! You can often still salvage the sale. You may want to consider one of the following alternatives to credit granting:
Offer to do the sale on the basis of a Letter of Credit (or LC). An LC is a document issued by the client’s financial institution that provides for an irrevocable payment to you as beneficiary. The advantage is that you can still extend terms to meet your customer’s needs (60 days for example) but feel secure that you will be paid upon submitting proof of delivery or similarly defined documents to the financial institution. This option is available where the customer has a line of credit with his financial institution.
Offer a discount for up-front payment. With today’s low interest rates, a customer may find a couple points discount for an up-front payment to be attractive. Just make sure the payment clears before releasing printed material. A cheque can bounce, or have a stop payment issued against it, days after you deposit it in your account. You might want to consider offering credit card payment for this purpose. The customer may even be attracted by the opportunity to earn loyalty points with their purchase.
Printers are not bankers. If you can’t satisfy yourself that a client is credit worthy, and you can’t find an alternative to extending credit, then walk away. Remember, the bad debt avoided is worth 10 or more times the sales opportunity missed.
Bob Kadis, Vice President, Finance & Administration at Harmony Printing Ltd. in Toronto, is a CA with 25 years experience in the print industry.
rkadis@harmonyprinting.com
