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How to fine-tune a credit policy.

As banks react to a sluggish economy and increased loan losses, even healthy middle-market businesses are finding it tough to obtain financing. At the same time, even the owner of a growing business is faced with the challenge of protecting the company from financial problems his or her customers may be experiencing. Although a business owner may have to select which customers to keep and which to refuse credit to, there are other ways to improve management of your customer base during tight-money periods.

For example, extending credit enables a company to retain key customers, paves the way for future price increases and gains for the business a competitive advantage over vulnerable competitors. Shortening credit, on the other hand, helps preserve the company's capital and protect it from the tough times ahead.

The proper balance of credit differs from one customer to the next -- and may even change from one month to the next. Changes in conditions of each customer and in the business continually must be monitored so that informed credit decisions can be made.

The first step in evaluating credit policy should be to collect as much information as possible on the credit and capital requirements of customers and competitors. This can help a business owner determine if the credit terms the company currently is using need to be changed. Of course, the company's capital requirements are an important part of the puzzle.

Sales and marketing personnel often are the best sources of credit and capital information outside the company. Being on the front lines, they know when competitors are offering better credit terms and when they are getting tough with late payers. If properly trained to gather information, sales people can get a good handle on their customers' financial conditions and credit concerns.

The types of business the firm's customers are in and the geographic areas in which they operate also should be examined. At any given time, different industries are in various business cycles, and the availability of credit is rarely uniform in all parts of the economy.

For example, companies that manufacture windows for the new home market may have a customer base with credit problems when the housing market is weak. But because home-improvement sales usually expand in times of poor housing markets, companies that make products for the retail home-improvement market may see the quality of customer credit improve.

As soon as a company discovers changes in credit conditions of its customers, management should take actions on credit that minimize the risk of losing customers or market share without damaging profits. Following are several examples of how to take advantage of changing market conditions.

If a company's credit is solid, but a competitor has recently acquired more debt, credit could be extended from 30 to 45 days. Assuming the business has access to adequate credit lines, this strategy is particularly appropriate when interest rates are low. Credit extension offers the opportunity to increase market share or raise prices because customers are getting better credit terms.

Business managers should consider each customer's credit situation. For customers experiencing tight credit from their bankers, extending payment terms to 45 days may do no more than simply increase uncollectible debts. It may be smarter to agree on incremental payments over a longer time period -- even 60 to 75 days.

If some customers are experiencing tighter credit than others, a company should consider using tactics such as offering volume discounts instead of making a general change in credit terms. That strategy enables a company to retain troubled customers -- and boost sales to the other, more creditworthy customers.

A company with a credit problem may have no choice but to tighten credit to customers. If competitors also are tightening credit, there may be no loss of market share. But to ensure competitive credit terms in tight times, the business should consider discounts for faster payment. This strategy might be particularly useful for companies with high margins and extended terms because the nominal loss of margins will not be as significant as it would be for high-volume, low-margin companies.

If a company's banks, as well as the banks of key customers, are tightening credit, it may be wise for the firm to shorten terms for customers, even if the action results in loss of customers that can't meet the tougher terms. At least the business will come out of the credit crunch with fewer bad-debt losses. Those companies that remain loyal customers are likely to be in the best cash position. Again, the company also should consider discounts or a combination of discounts and a price increase.

Because a firm's credit policy becomes a part of its strategic decision-making, business owners and managers must be careful not to make decisions in a vacuum. Accountants can save a company time and money with professional advice on credit and other business decisions.

Involving marketing and sales personnel in gathering intelligence and explaining a policy change to customers is important not only as an information resource, but also because it enlists their vital cooperation in implementing policy. A company's bankers also should be involved; they do not want to be surprised by a sudden change, up or down, in receivables without advance discussions of changing credit terms. Finally, before a business offers different credit terms to different customers, an attorney should be consulted. Even if differences are based on volume, state or federal fair-trade laws may be violated.

Entrepreneurs are known for their ability to overcome adversity. By taking a potentially dangerous situation and turning it to advantage, business owners and managers can help increase a company's odds of success.

Thomas Wilford is the managing partner of the Anchorage office of Ernst & Young, an international accounting firm.
COPYRIGHT 1992 Alaska Business Publishing Company, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992 Gale, Cengage Learning. All rights reserved.

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Author:Wilford, Thomas
Publication:Alaska Business Monthly
Date:Feb 1, 1992
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