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A credit look at new customers.

THE PROCESS OF SETTING CREDIT TERMS FOR a new business customer usually presents a greater challenge than deciding on a change in credit terms on existing customers. When a company is establishing a new relationship with a customer, it involves entering into more uncertain realms, except for those customers that are well-known and well-established corporate entities. Brand new businesses generally represent the biggest challenge because there is less information available on them, nor is there much--if any--payment history on them. Several credit managers related some of the major considerations and factors they look at when deciding on credit terms with new customers. While there is a degree of consensus on these factors, there are variations among them based on their specific industry, the type of customer involved, prevailing market conditions, the products or services being sold and whether the sales are domestic or international.

Most experienced credit professionals are aware of and engaged in evaluating factors contained in the Five "Cs" of Credit: character, capacity, capital, conditions and collateral. John Lipschutz, CICP, Global Credit Manager for Eaton Power Quality, believes that after evaluating factors within these five categories, "It becomes pretty clear what to do." Lipschutz, who is involved in international trade, said that for him, the sixth "C" is currency. He noted he considers how stable a country's currency is as part of his credit evaluation for international customers. For Malinda Klein, CICP, Sr. Credit Manager, Eastern U.S., Wayne-Dalton Corp., one of her first considerations is to verify with the appropriate secretary of state whether the company's name is listed correctly on the credit application and whether it is a bona fide company. Kevin Brashear, CCE is Manager of Credit & Collections with TXI Operations, a Texas-based supplier of cement and aggregates. He said that if the customer is a private company, with less information about it publicly available, he will look into whether the construction job that customer is involved in is bondable and lienable before deciding on credit terms.

Pete McNiffe, Credit Manager for the U.S. for GE Plastics, said he usually tries to get financial statements as a starting point in establishing credit terms. He mentioned that he is only occasionally successful in getting them, because only 25 percent of his customers are public companies. "The majority of times, we make our decisions without them." Darin Woodward, Senior Manager of Credit and Collections, for ACN, Inc., said, "The audited financials will give you a good idea of what financial direction a customer is heading in." Lipschutz noted that he compares various financial ratios for successive years to determine financial trends of a customer; especially looking to see if the customer's financial picture is deteriorating over time. Tina Sorrels, CICP, Director of Credit for AJC International, a food products exporter and importer, said that when financial reports are hard to obtain, as is sometimes the case with international customers, she will try to obtain whatever financial information she can. "The ones that won't give you financial statements will give you highlights, and we extrapolate from that."

Trade references are also very useful because they show how a customer is paying other suppliers; Sorrels said she looks to trade as well as bank references. Payment status to other companies is often a good predictor of how that customer will pay a new supplier. Lipschutz noted that if a prospective customer is not paying one of his competitors, the chances are his company is not going to be paid either. Ron Moore, Corporate Credit Manager for Flowerwood, a plants supplier, concurred that he would not take a chance on offering credit terms to a customer that was not paying his competitors on time. "Why should I put them on 30-day open terms when they're already past due on their other accounts?"

A convenient and effective way to tap into a treasure trove of financial and trade line information on customers is to join an NACM credit group. Members often have similar customers so the chances are good that a potential customer for one member of the credit group has been, or is, a customer of one or more of the other credit group members. Credit group members benefit from having easy access to trade line and other financial information on customers, as well as ways of being instantly alerted to a negative payment situation of a customer, such as an NSF check. Additionally, Sorrels seeks information from his NACM Affiliate, as well as from FCIB (Finance, Credit & International Business), NACM's international arm. "I often contact NACM when I get into a bad predicament with a customer," Sorrels added.

NACM Affiliates provide credit reports too; generated by themselves or a third party--but offered at a reduced rate to NACM members. While some credit reporting agencies offer a credit score about a company on their reports, a growing number of companies are computing their own credit scores based on aggregated credit-related data they acquire from multiple sources. Brashear pointed out that his company relies a great deal on credit scoring as a key ingredient in its credit decision-making process. "We run every company through a credit-scoring model. The score is the baseline for how we review our customer."

Deciding upon credit terms is not just a quantitative matter of analyzing and crunching numbers. Credit department staff as well as those who operate the customers' businesses constitute the qualitative human element of business credit. The human element of trust is an essential ingredient in credit relationships. For Moore, certain warnings signs are triggered by particular customer behaviors; for example, he will be reluctant to grant credit if a customer is in a hurry to get credit approved, when his normal credit review process takes from 6-14 business days. "Why are you waiting until the last minute to do this?" is a question this behavior warrants, he said. He also becomes skeptical when a customer displays a demanding attitude during the credit approval process. "I have no problem declining somebody in those cases," he added.

Brashear contends that visiting the principals of a business at their company is a good way to gather credit information. Lipschutz agreed, and said he likes to go with his sales staff to visit customers. "There's no substitute for a face-to-face visit with the customer at their business." Sorrels said she often visits countries where there are international markets that are booming, or that represent new markets for her company's products: "You really get to see the character of the customer: I think international travel is the best education in the world."

New management techniques adopted by many companies require an integrated or system-wide approach to various business processes. Such approaches involve a close coordination among various company departments, where sales and credit departments work seamlessly together. McNiffe pointed out that his credit department takes that approach with the sales department, relying a great deal upon customer information presented by sales personnel. "We want to make sure both sides are beating to the same drum before we go back to the customer," he said.

International sales present another layer of consideration referred to as "country risk" (see the article, Bolivia's Country Risk--Should It Change Credit Terms? on page 37 in this issue). Such factors that make up country risk include the political environment of the country or region, the status of the economy, culture and currency status. Sorrels pointed out that she often consults with the embassy of a country to discover which companies are subject to financial or other troubles. She also consults with information provided by the U.S. government about companies and individuals with links to terrorist organizations, money laundering and other illegal activities. The U.S. government maintains lists of suspect companies and individuals that Sorrels said are a must-review for those doing business internationally. "It's very important that you perform due diligence ... not conducting business with a suspect foreign company or individual," she added. In rare cases, the country risk is so high that doing business with even a financially reputable and sound company is ill advised. Pointing to Haiti, Sorrels said, "The country is an absolute mess. There's rioting and shooting in the streets."

Effective credit managers work hard to bring in new business. In situations where not enough information is known about the customer or the financial picture presents more risk than a company can tolerate, there are risk mitigation tools available to help approve the sales contract. The credit managers polled in this article pointed to several such tools such as letters of credit, personal and corporate guarantees, and collateral as ways to mitigate risk in order to establish credit. McNiffe noted that he tries to employ these tools in a creative fashion to establish credit: such risk mitigation tools are a way for the customer to share the risk with his company. His general rule is, "What would I need from the customer to help me sleep at night?"

Lipschutz said that the profit margin in the sale determines, to an extent, the level or risk he is willing to take: "If it's a high margin, we might assume more risk." For new businesses, with little or no payment track record, a personal guarantee or corporate guarantee from an affiliated or parent company is required. Agreeing to sign a personal or corporate guarantee also may be a sign of how confident and committed the customer is that he or she will be able to pay on a timely basis, said Brashear: "If a customer wants me to take all the risk, that says a lot about their company."

The subjective element in business credit decision-making is inevitable--and that is where the skill and experience of a credit professional is invaluable. "A lot of this goes by gut feeling," Moore said, referring to cases where the credit status of a customer is hovering between acceptable and unacceptable risk. However, he has granted credit terms in some of those borderline cases. He noted his track record when he granted credit in such cases is not perfect: "I've been fooled by a few folks."

"Credit is never black and white," Brashear added ... "I can't tell you if it's a borderline case, we never grant credit." Klein said the level of risk her company accepts is influenced by market conditions. "If your industry is skyrocketing, you can take a little more risk," she said. "If the economy is in a downward trend, you'll be more conservative with those risky customers." For Lipschutz, his subjective judgment to stretch a company's credit limit is based on trust; however, he added, "For new businesses, we're not as trusting."

Prospering companies are constantly seeking out new business in order to keep growing. This involves not only expanding business with existing customers but also establishing business with new customers. New customers often present a higher degree of uncertainty for credit professionals. However, seasoned credit professionals know where to acquire the information they need to make good credit decisions related to new customers. They also know how to be creative and reduce risk when necessary. Although new analytical techniques and sources of credit information make it easier to make credit decisions, nothing is likely to replace the skill and judgment of a good credit professional in the foreseeable future.

Huge Potential for Automation and Software Vendors

As global automotive manufacturers face extreme competition, they are looking to adopt common automation and software architecture at all global locations to drive operational efficiency and reduce costs. New analysis from Frost & Sullivan finds that automation and software solutions in world automotive markets earned revenues of $5,813.1 million in 2005 and estimates to reach $9,963.1 million in 2012. The competition in the automotive market has increased manifold with no market being considered as a safe market as a result of globalization. Automotive manufacturers and their suppliers are forced to replicate the best practices followed in a particular plant at all their global locations to maintain uniform quality and maximize productivity. This also necessitates effective communication channels between OEMs and their suppliers on a global platform, which explains the need for automation and software solutions for the automotive market.

The rise in the cost of raw materials coupled with the worldwide increase in gas prices has created an unfavorable environment for automotive manufacturers. They are in turn passing on costs down to their suppliers who are facing an even greater crunch. "The major automotive manufacturers in the U.S. are also facing huge costs on account of their contractual obligations to its workers and pensioners," says Frost & Sullivan Research Analyst Sanjeev R. Sridharan. "This has further pulled down their profit margin, thus marginally denting their purchasing power. However, the need to create a leaner and more efficient workflow to attain operational excellence has driven automotive manufacturers to invest in newer standards based automation and software solutions."

The key success factor for automation companies is to establish long-term partnerships with automotive customers. Even as automotive customers look for standardization, automation companies need to grow aggressively with their automotive customers as they expand globally. The relationship starts from educating and generating awareness among customers. Having selected specific automotive engagement opportunities, it is important for automation vendors to build critical momentum and achieve a dominant business differentiator. Once automotive customers are reasonably satisfied with the metrics, they are more comfortable awarding repeat orders at many other global locations. Long-term partnerships could prove to be profitable to both the automotive industry as well as the automation vendors.

Source: Frost & Sullivan

Tom Diana may be reached via e-mail at
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Title Annotation:new business
Author:Diana, Tom
Publication:Business Credit
Geographic Code:1USA
Date:Jul 1, 2006
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