ESSENTIALS of Credit, Collections, and Accounts Receivable TEAMFLY Team-Fly ® The Essentials Series was created for busy business advisory and cor- porate professionals.The books in this series were designed so that these busy professionals can quickly acquire knowledge and skills in core business areas. Each book provides need-to-have fundamentals for those profes- sionals who must: • Get up to speed quickly, because they have been promoted to a new position or have broadened their responsibility scope • Manage a new functional area • Brush up on new developments in their area of responsibility • Add more value to their company or clients Other books in this series include: Essentials of Accounts Payable, by Mary S. Schaeffer Essentials of Capacity Management, by Reginald Tomas Yu-Lee Essentials of CRM:A Guide to Customer Relationship Management, by Bryan Bergeron Essentials of Intellectual Property, by Alexander I. Poltorak and Paul J. Lerner Essentials of Trademarks and Unfair Competition, by Dana Shilling Essentials of Corporate Performance Measurement, by George T. Friedlob, Lydia L.F. Schleifer and Franklin J. Plewa, Jr. For more information on any of the above titles, please visit www.wiley.com. Essentials Series ESSENTIALS of Credit, Collections, and Accounts Receivable Mary S. Schaeffer This book is printed on acid-free paper. Copyright © 2002 by Mary S. Schaeffer and the Institute of Management and Administration. All rights reserved. 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Limit of Liability/Disclaimer of Warranty:While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies con- tained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. Library of Congress Cataloging-in-Publication Data Schaeffer, Mary S. Essentials of credit, collections, and accounts receivable / Mary S. Schaeffer. p. cm. ISBN 0-471-22074-4 (pbk : alk. paper) 1. Credit—Management. I. Title. HG3751 .S334 2002 658.8’8—dc21 2002005070 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1 ∞ For my princess, Larissa Mary Noelle Ludwig, my wonderful, beautiful, gifted daughter 1 The First Step: Approving the Credit 1 2 The Second Step: Billing 29 3 The Third Step: Collecting the Money 49 4 Accounts Receivable Issues 81 5 Handling Deduction Issues 103 6 Interacting with Sales and Marketing 115 7 Customer Relations and Customer Visits 133 8 Letters of Credit and Other Security Interests 147 9 Legal Considerations Surrounding Credit 163 10 Bankruptcy 183 11 Technology in the Credit and Collections Department 215 12 Professionalism and the Future of the Credit Profession 241 Index 253 vii Contents C redit is part science, part art, and part gut-feel. The trick is to get the right mix.While there is no one absolute right way to handle the credit, collections, and accounts receivable functions, there are a few that are totally and irrefutably wrong. It is the mission of this book to identify both for the reader. For the last eight plus years, I have been lucky enough to spend my days talking to credit professionals and writing about their successes and achievements, their trials and tribulations, and occasionally their catas- trophes as a newsletter editor for IOMA’s Report on Managing Credit Receivables and Collections. Much of what they have told me is reflect- ed in this book. Thus, the suggestions and recommendations are not pie-in-the-sky advice but rather practical guidance based on real life accomplishments and failures. Before reviewing what is covered in the book, I’d like to point out that there are many ways these functions can be handled. Often what works at one company will not at the next. This can be because the second company doesn’t have the technology of the first, and because the corporate culture is very different or can be simply due to differing industry requirements.Thus, many of the topics in the Tips & Techniques will cover a variety of approaches—some applicable to more sophisticated companies and some to the less advanced. The book starts with a look at approving credit.This should be the first step for companies before they begin a relationship with a new customer —although as many reading this are only too well aware, it occasionally ix Preface occurs after the fact, after the salesperson has taken the order. Chapter 1 begins with an explanation of why business credit is so important, verifies that a business does exist, and examines financial statements in detail.The chapter takes a look at the way companies evaluate credit, the information many require on their credit applications, and the references many require. Ratio analysis, how companies evaluate new customers, and what docu- mentation should be in the credit file are also examined. Many companies overlook the importance of their billing practices in the credit and collection process. An invoice mailed late will get a payment posted even later. Chapter 2 takes an in-depth look at invoices, the best way to design an invoice and best billing practices. An outsider might not realize that there are many things companies can and should do to their invoices to improve their ability to collect in the most timely and efficient manner and ultimately the company’s bottom line. Electronic invoicing is one of the hottest topics in the credit arena today. Chapter 2 takes a look at the practice and also offers details about five of the products on the market today. Electronic invoicing is likely to have a big impact on business in the next few years, and thus it is imperative that credit and collection professionals learn everything they can about it. The book then goes on to take a look at the thankless task of col- lecting. Many in the collection profession feel that at best they break even. If they do a good job, no one notices, but the moment collections slip,management is watching them like a hawk and complaining. Unfor- tunately, many who have this complaint are quite accurate. Chapter 3 contains numerous tips that have worked for professionals in the field today. We look at both the old-fashioned letter writing and the more current practices of phoning, e-mailing, faxing, and whatever else inno- vative collection professionals can dream up to get the money in the bank for their companies. x Preface [...]... know about and avoid breaking as part of their job Chapter 9 takes a look at some of the legal considerations surrounding credit and collection activity Perhaps one of the most fascinating aspects of credit is bankruptcy It is a regular part of most credit managers’ jobs no matter how good they are Chapter 10 describes the different types of bankruptcies, the rights of creditors, and what creditors... In cases where the credit of the customer is questionable and the margins on the product high, a number of credit professionals simply ask for cash in advance for the portion that relates to the out -of- pocket costs Then if the final payment is not received, the company only loses its profits This also demonstrates to the customer a 13 ESSENTIALS of Credit, Collections, and Accounts Receivable willingness... financial analysis may indicate 11 ESSENTIALS of Credit, Collections, and Accounts Receivable that the customer should not be granted credit terms, but there are often other factors to be considered Here is a brief look at some of the nonfinancial issues that affect the final determination: • The 5 Cs of credit: character, capacity, capital, conditions, and collateral One credit analyst revealed that his... analysis, capacity, and other key factors are all part of the credit line granting process • Have the board of directors revise and clarify credit policy and terms TE • Divide the credit application into two parts: the credit agreement and the application for credit • Streamline the new account set-up process • Assign one person to set up new accounts, send out credit applications, and process them once... mention of a company called IOMA (Institute of Management and Administration), a New York City-based newsletter publisher IOMA is the company I work for and the publisher of, among many others, a monthly newsletter called IOMA’s Report on Managing Credit, Receivables & Collections In my position as editor of this publication since 1994, I have had the opportunity to interact with hundreds of credit and collections. .. company’s credit standards for open account terms When this happens, the savvy credit pro finds a way to make the sale happen—usually by getting some sort of security Chapter 8 examines some of the techniques that credit professionals can recommend in order to make the sale happen Some professionals think that credit professionals really need to be lawyers first There are a number of laws that credit professionals... completed credit application • Work with sales on the credit application process Make sure they get a signed contract and authorization rather than just a verbal commitment 15 Team-Fly® ESSENTIALS of Credit, Collections, and Accounts Receivable • Make the credit approval for all new customers consistent Require the same information from all before credit is granted Once the process is standardized,... existing credit staff to make sure they all understand the nuances of credit and are using the same corporate standards • Hire a full-time credit administrator to monitor the creditapproval process Existing Accounts Just because a rigorous credit evaluation was completed when a company first becomes a customer does not mean that analysis is good forever Most experts recommend that credit reviews of all accounts. .. 19 ESSENTIALS of Credit, Collections, and Accounts Receivable • During the first quarter, accounts with limits over $25,000 are reviewed In the second quarter, those with limits between $10,000 and $25,000 come under scrutiny The third quarter is spent focusing on those with lower limits, and the fourth quarter is spent making sure that credit files for every active account are in place and updated Credit. .. sale of a facility, a change in accounting methods, a large tax credit, or a write-off If you find such items, recalculate the income statement, and then redo your ratio analysis based on the new numbers After all, if the only reason a company showed a profit was that it sold a piece of real estate, this is a one-time gain that is unlikely to happen again 7 ESSENTIALS of Credit, Collections, and Accounts . include: Essentials of Accounts Payable, by Mary S. Schaeffer Essentials of Capacity Management, by Reginald Tomas Yu-Lee Essentials of CRM:A Guide to Customer Relationship Management, by Bryan. electronic books. Library of Congress Cataloging-in-Publication Data Schaeffer, Mary S. Essentials of credit, collections, and accounts receivable / Mary S. Schaeffer. p. cm. ISBN 0-4 7 1-2 207 4-4 (pbk. Essentials Series was created for busy business advisory and cor- porate professionals.The books in this series were designed so that these busy professionals can quickly acquire knowledge and