The information below is published courtesy of Credit Services Corporation and Michael C. Dennis.

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	Cash Flow and Collection
	Choosing a Commercial Debt Collection Agency
	An Introduction to Chapter 11 Bankruptcy
	Negotiating with Delinquent Debtors
	Sixteen Collection Tips
	Ten Myths About Credit Management
	The Credit Department of the Future
	When to Place an Account for Collection
	More Telephone Collection Techniques
	How Credit Professionals Can Put the Internet to Work
	Ten Steps to More Successful Debt Collection
	The Power Equation in Business to Business Collections
	The Limitations of Financial Statement Analysis

By Michael C. Dennis, MBA, CBF

Republished in the February 2004 edition of Business Credit Magazine and reprinted here by permission

There are a number of excellent national and regional commercial collection agencies. Out of respect for those I do not know, I will not name any in this article. The things to look for in a collection agency are:

1. Performance, performance, performance! Realistically, we all know that by the time we place an account it may very well be (DOA) Dead on Arrival when we submit it. Nevertheless, you should monitor the performance of the agency or agencies you use.
2. An opportunity to meet face to face with a representative of the agency at least quarterly to discuss their performance level, your goals, your expectations, and their collection efforts.
3. Prompt and accurate reporting of the agency’s collection efforts, and prompt reporting return of all payments received from a debtor company.
4. The collection agency is not reluctant to recommend that the matter be placed in the hands of an attorney if the debtor refuses to work with ‘your’ agency. The threat of referring an account to an attorney to file suit may be the only way to extract payment from an uncooperative debtor.

Most credit managers receive sales calls from collection agencies on a regular basis. If you are serious about establishing a relationship with a new collection agency, it should be unnecessary to take an adversarial stance or haggle with an agency when discussing contingent collection fees [collection rates]. A key element of the credit department's relationship with a collection agency is mutual respect. If that respect is not evident when the collection agency quotes fees [for example, when a collection agency quotes a fee structure rate that is above the going rate] there is little reason to continue the discussion.

When you discuss a relationship with a third party collection agency, you should try to:

• Deal from a position of strength. Remember that there are dozens if not hundreds of commercial collection agencies to choose from.
• Make certain that the agency understands that if a large claim is placed you will ask them to quote a rate below their standard contingent fee structure.
• Ask how small a claim the agency will accept.
• Not get too "chummy" with the salesperson. Doing so might make it difficult for you to remain objective.
• Question the experience and level of expertise of the collection agents that will be charged with servicing your account placements. The salesperson soliciting your business is not necessarily representative of the level of professionalism and proficiency among other employees of the collection agency. The company’s collectors have to be able to do their jobs effectively in order to improve the chances of recovery on accounts placed for collection.

Some general rules for choosing a commercial collection agency include:

• Work only with collection agencies willing to work on a contingent collection basis.
• If you sell nationally, deal with an agency with a national presence. If you sell regionally, you may find a smaller local agency gives you better service.
• Make certain that the agency is licensed and bonded.
• Be sure there is a written agreement with the agency specifying items such as:
  • The basic contingent collection rate or fee structure
  • What happens if the debtor remits payment during the free demand period
  • How the agency will be paid if the debtor proposes a return of product to satisfy the debt
  • The rate if the account must be placed with an attorney
  • How soon you will receive payment once the collection agency receives payment from the debtor
  • What happens if the debtor company files for bankruptcy protection

Not all collection agencies work the same way. Some collection agencies approach debt collection by generating a series of progressively more strident dunning notices. Other agencies combine dunning notices with phone calls to delinquent customers. Other collection agencies combine dunning notices with phone calls and unannounced personal visits to the debtor’s place of business. As a rule, agencies that only send dunning notices are less effective than agencies that call customers. Agencies that call debtors may be slightly less effective than collection agencies that visit customers to discuss past due balances face to face – but these collection agencies may charge a premium for this type of service.

Therefore, before selecting a collection agency you need to know how they go about the collection process. You need to measure the rate quoted against the manner in which the agency goes about the collection process and factor in the chances of success using this collection method. Thus, the agency that offers the lowest fee may not be the agency that offers the ‘biggest bang for the buck.’

A final thought: Since most of the recipients of Business Credit Magazine are NACM members, chances are good that they are aware of or a member of a NACM local affiliate association. Many local affiliates have in house collection services available to members. Because they are member owned, affiliates can offer very competitive contingent collection rates. Some of advantages of using a NACM affiliate association’s collection division include instant credibility, honesty, trustworthiness, professionalism, and the fact that your local affiliate is not likely to ‘hound’ you for more business. In addition, the local affiliates’ collection divisions work closely together to provide effective nationwide services to member companies.

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An Introduction to Chapter 11 Bankruptcy

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© 2002. Credit Services Corporation. All Rights Reserved

Bankruptcy is a federal court process designed to help consumers and businesses eliminate their debts, or repay them under the protection of the Bankruptcy Court. A voluntary Chapter 11 filing is an action taken by a company to resolve financial problems such as lack of liquidity or excessive debt. During the Chapter 11 process, a company is able to continue to conduct business while reorganizing its finances and operations in order to pay the claims of those to whom it owes money.

The goals of a company in Chapter 11 Bankruptcy are [1] to "reorganize" its business and [2] to try to become profitable again. A company in Chapter 11 may continue to sell goods, and to employ workers. It is also able to purchase on open account terms, and to borrow money from banks.

A company exits Chapter 11 when the U.S. Bankruptcy Court has approved a Chapter 11 Plan of Reorganization, and the transactions and payments proposed in the Plan are consummated. The U.S. Trustee will appoint one or more committees to represent the interests of creditors and stockholders in working with the company to develop a Plan of Reorganization.

Before the Chapter 11 Plan may be implemented, the debtor in possession must send the creditors a court approved disclosure statement, and obtain acceptance of the plan by its creditors. Even if pre-petition creditors vote to reject the Plan, the Court can disregard the vote and still confirm the Plan if it finds that the Plan treats creditors and stockholders fairly. A class of claims is considered to have accepted a Plan if such a Plan has been accepted by vote of creditors that hold at least two-thirds in dollar amount, and more than one-half in number, of the allowed claims of that class.

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© 2002. Credit Services Corporation. All Rights Reserved

These are some steps that should be taken in negotiations with delinquent debtors:

• Ask what caused the delay in payment.
• Ask how serious the problem is and what the customer is doing to resolve the problem.
• Always ask for immediate payment in full.
• Know what is the least you will accept from the debtor/customer before making the collection call.
• Ask the debtor to acknowledge the debt in writing.
• Request a substantial, immediate payment as an indication of the customer's good faith
• Propose an aggressive repayment plan, and then ask for the debtor's comments about your proposal.
• If the customer agrees to your proposal, arrange for them to confirm it to you in writing - even if it only an e-mail.
• If the customer rejects your payment plan, insist that they make a counter offer.
• Do not accept any counter offer immediately. Think it over carefully.
• If the customer's proposal is below your minimum acceptable level, reject it immediately. Doing so sends a message that you are serious about the negotiation process, and are not about to be "low-balled" by the debtor.
• Remember that a delinquent customer's first offer is a "sucker" deal intended for inexperienced or unprepared trade creditors.
• Consider asking the debtor to return inventory to clear part of the debt
  • If the inventory has kept its value, and
  • Assuming you believe there is little or no chance that the debtor will file bankruptcy within 90 days of returning the product.
• Ask your customer to provide security or collateral in exchange for extended time to pay the debt.
• Approach negotiations as equals. If you do not act and speak as an equal, you will be at a serious disadvantage.
• Ask the customer for additional information that would help you to understand the scope and extent of their financial problems.

Unfortunately, some collectors seem to prefer to call and take notes about payment commitments offered by the customer rather than to negotiate for a better payment plan. It is the credit manager's responsibility to make certain that every collector is negotiating for the best payment commitment the creditor can get.

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© 2002. Credit Services Corporation. All Rights Reserved

Start your collection discussion by demanding immediate payment in full. Don't be in a hurry to make any concessions to a delinquent customer. In addition, collectors should:

1. Approach the debt collection process systematically.Set specific and measurable goals for yourself and your subordinates. Try not to leave voice mail messages. Call back and ask the operator to speak to a "live" person. This works more often than you might think.If you must leave a message, keep it simple. Give your name and number at the beginning and the end of the message.Ask for a return telephone call the same day.If there is an order pending, be sure to share this information. For many accounts payable departments, an order on hold automatically triggers a payment and a return call to the creditor company.Don't use your speakerphone on routine collection calls. Doing so is considered rude.Don't waste time your time or your customer's time. Get to the point of the call. Discussion of the weather or ball game score can wait. Keep personalities out of the collection discussion. Avoid confrontations. Remain calm.Pay attention to the customer's replies to your questions and comments. Take notes throughout the conversation of key points, comments, and commitments. Always review your previous collection notes before making a collection call.Follow up promptly on any broken payment commitment - asking why it happened, why you were not notified, and when the payment will be made.Shorten the collection cycle by faxing rather than mailing any requested supporting documents - even when there are a large number of documents to send.Make certain your collection calls are interactive. If the customer is not communicative, be direct. Ask for their comments and feedback.
2. When an account slows payments, contact the trade references originally provided to see if the problem is unique to your accounts receivable. 

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© 2002. Credit Services Corporation. All Rights Reserved

There are many myths about credit management. Some of these myths are the creation of customers, order entry personnel, and salespeople. Here are ten of the more common myths:

1. Myth: Sales and credit are in opposition in a "zero sum game" meaning that if one wins, the other loses. Reality: Sales and credit can work together to increase sales and profits while moderating credit risk.

2. Myth: The larger the balance due, the more experienced the collector should be. Reality: Routine collections can be handled by a junior collector, meaning that more experienced credit personnel can be assigned when situations require experience, maturity, common sense and expertise.

3. Myth: An all-out collection effort will collect almost every delinquent accounts. Reality: The time to manage risk is before orders are released - after the order is released the cat is out of the bag.

4. Myth: Creditors should allow a grace period before calling on a past due balance. Reality: Allowing a grace period simply means that until a call is made the creditor will not know if or when payment is forthcoming.

5. Myth: Asking for a financial statement always upsets customers. Reality: Requesting an updated financial statement rarely upsets customers. Privately held companies may decide not to share the requested information, but requesting financial statements on accounts identified as high risk should be part of the normal risk management routine.

6. Myth: It is never a good idea to involve salespeople in the collection process. Reality: Salespeople should not be allowed to negotiate payment plans, but salespeople can be used effectively to bring additional pressure to bear on the customer through the purchasing department.

7. Myth: All collection agencies are created equal. Reality: Collection fees and services and overall effectively varies widely. Some collection agencies only write letters. Others only contact customers by phone. Some agencies arrange for a collector to visit the debtor in person. The method of collection and the professionalism of the agency impacts on the collection results.

8. Myth: Credit managers should not force debtors into involuntary bankruptcy. Reality: Experience credit managers don't limit their options. If the likely recovery would be higher in a bankruptcy, then bankruptcy is a viable option.

9. Myth: Export credit sales are more trouble [and more risk] than they are worth. Reality: For many companies, international or export sales is an area of great potential. There are tools and techniques that credit professionals can use to moderate and mitigate some of the unique risks associated with doing business with a foreign customer on anything other than cash in advance terms.

10. Myth: Credit management is an art, not a science. Reality: It is both art and science, and it is neither. Most of the basic skills can be mastered by anyone. However, more sophisticated risk management and negotiation skills are more of an art than a science. 

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© 2002. Credit Services Corporation. All Rights Reserved

Students and seminar attendees sometimes ask what I see as the major changes that will take place in the typical credit department of the near future. Unfortunately, I foresee a number of significant challenges [and not much good news] on the horizon for credit professionals. I believe that in the future credit departments will:

• Be centralized, rather than decentralizedHave fewer total employeesInvolve some companies outsourcing the credit function as a "non core competency"Involve some companies folding the credit and collection department into customer service/customer supportBe more fully automatedUse sophisticated credit scoring software to identify problem accountsUse collection management software to prioritize and automate the collection processInvolve the use of deduction management softwareInvolve automated financial statement analysisUse artificial intelligence to screen orders pending in order to identify only those that truly need personal attention by the credit managerFurther automate the automatic cash application process now being used by some companies
• Use video conferencing or webinars rather than requiring attendance at industry credit group meetings 

What does this mean for the average credit manager? I think credit professionals need to redouble their investment in their own professional development. Credit managers should stay current with technological changes, and embrace the changes that reduce cost and headcount and/or make the credit department more efficient and effective. 

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© 2002. Credit Services Corporation. All Rights Reserved

Collection agencies do a great job of describing why trade creditors should entrust your delinquent and uncooperative accounts to them. There do not seem to be any universally applied rules about when and why to place an account for collection. There are no hard and fast rules about when to turn an account over to a collection agency. However, Credit Managers should seriously consider doing so when the following conditions exist alone, or in combination:

• A customer has bounced checks to you or other vendors
• The customer refuses to replace the bounced check
• The creditor is no longer making progress toward clearing the unpaid balance
• If the customer will not take your calls
• The customer will not return your calls
• The account is 90 days or more past due
• Federal or state tax liens have recently been placed on the debtor company
• There is significant employee turnover in the company, especially among senior employees
• The customer has broken two or more commitments to pay the past due balance
• The customer promises to pay one amount, but pays significantly less
• The debtor refuses to acknowledge the balance due in writing
• The customer proposes a payment plan, but refuses to sign a Promissory Note
• The debtor is considering filing for bankruptcy protection
• The customer is changing banks
• The debtor is in violation of its bank loan covenants
• The delinquent customer cannot pay until arrangements with a new bank are settled
• The bank has frozen the customer's account
• The debtor issues a check placed on a closed
• The company was recently sold
• There was a bulk sale of assets
• The customer has proposed a payment plan to trade creditors as an alternative to a bankruptcy filing
• A customer asks you to speak with their "work-out" specialist
• When you threaten to place the customer for collection, and they seem unconcerned
• The customer's phone is disconnected
• Your mail is returned
• When there has been an ownership change
• The new owner claims not to be responsible for the debts of the former owner(s)
• If you cannot reach a decision maker
• You cannot get a reasonable commitment for payment from the decision maker
• You learn the customer is being sued by other trade creditors
• The account has been placed for collection by other trade creditors
• The business is for sale
• If you are told the business is for sale
• You are offered payment only after the sale is completed
• Creditors that once sold the customer on open-account terms now sell on COD terms
• There is significant deterioration in payments to creditors
• The debtor company does not respond to a final demand for payment

The more of these facts apply, the more likely that it is time to place the customer for collection. Any unnecessary delay in placing an account for collection can reduce the likelihood of recovery.

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© 2001 Michael C. Dennis

Collection calls should be made without delay as soon as an account has become delinquent. Some companies establish a grace period before any collection calls are made. This is an invitation for customers to delay payments, and there is no advantage to the seller of allowing any grace period of this type. Collectors should keep the initiative by making collection calls, rather than leaving messages [which often go unanswered anyway]. The advantages of placing the collection call are:

• The caller has time to gather information and review their notesThe collector can discuss strategies with their managerThe caller can find out if there are orders pending or on hold, and
• The collector can prepare mentally for the call, and for any ensuing negotiation.

In summary, placing the call gives the collector the advantage of position and preparation. Don't waste time trying to contact the same person more than twice. Instead, use the "two and up rule". If you have called twice and left messages each time but you are still unable to reach accounts payable, change tactics. Move to the next level. If you started by calling the accounting manager twice, contact the controller. If the controller does not respond after two calls, contact the CFO. If the CFO fails to respond to your calls, contact the company President or owner. Timing of collection calls is critical. Placing a call too early in the day or too late in the day is unlikely to produce the desired outcome. Doing so gives customers a built in excuse for not answering their phone. Try to schedule collection calls in your customer's "prime time" which is typically between 9:00 and 12:00.

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© 2001 Michael C. Dennis

If you know where to look, the Internet provides can provide credit professionals with plenty of useful information about their customers. Unfortunately, there is so much information on the Internet that you could "surf" for hours without success unless you know where to look. To shorten the search process, some useful websites are listed below:

1. Exchange Rate Converter http://www.olsen.ch .  This site offers currency conversions on 164 foreign currencies. Carlson On Line Services http://www.fin-info.com.  This site provides information about Canadian public companies for companies listed on the Alberta, Montreal, Toronto and Vancouver stock exchanges. It also contains recent press releases, as well as links to the home pages of numerous Canadian public companies. Bloomberg Personal http://www.bloomberg.com.  One of the most useful features of this site is access through the company directory search to information about over 10,000 U.S. companies (as well as some Canadian companies) including a summary of what each company does, stock quotes, SEC documents, and financial information. National Fraud Information Center http://www.fraud.org.  This site includes fraud watch daily reports and archived fraud information reports. UPS Package Tracking. http://www.ups.com.  This site allows you to track the status of packages sent using UPS and order proof of deliver on line.
2. FedEx Standard Tracking. http://www.fedex.com.  This site allows visitors to track the status of any FedEx package - even if the package is still in transit. Users can also order POD on line.

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© 2001 Michael C. Dennis

Some credit professionals would argue that there are no secrets to commercial debt collection; that what is required is tenacity and hard work --- and they would be partially correct. Hard work will go a long way towards collecting from many delinquent customers, but hard work alone will never solve every collection problem. Listed below are a dozen ways that collectors can become more effective debt collectors quickly:

1. Make more collection calls. Organize calls by time zone. Prioritize calls in order to address larger problems sooner rather than later. At the same time, place a premium on the quality of calls rather than strictly on the quantity of calls completed. Be more assertive; expect more from each collection call placed. Keep the initiative by making calls rather than leaving voice mail messages and hoping for a return call. Leave a message only as a last resort. If you must leave a message, avoid phrases such as "please return this call at your earliest convenience" or "call as soon as possible." Ask for an immediate return call. If there is an order pending, emphasize this fact in your message. Always request and expect payment in full of the past due balance. Don't rush through a collection call. Instead, take the time to confirm payment commitments. Make certain that the sales department [or sales order entry if applicable] is reviewing purchase orders so that orders with unacceptable terms are rejected. Be sure your credit application contains a personal guarantee. Use the guarantee as leverage with "reluctant" debtors. Make sure your invoices, statements and dunning notices list your terms of sale and discount policies. If your company offers cash discounts but certain customers are not taking the discount, contact those customers' controller to "encourage" them to pay soon enough to earn the cash discount.
2. Be sure the telephone is your department's primary collection tool. Letters, faxes, and dunning notices are one-way communication --- only phone calls and personal visits involve two-way communication between the creditor and the debtor. It is easy for a debtor to ignore a letter, but far more difficult to avoid answering questions face-to-face or on the telephone.

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© 2001 Michael C. Dennis
 

It is important to understand the power equation in business-to-business collections. Failure to understand this essential element of the collection process weakens the creditor's ability to collect invoices as they come due. All of the following statements are generally true about commercial [business to business] collections:

1. Trade creditors have more power than they think they have. For example, the customer may need the creditors goods or services now or in the future, or may want to use the company as a credit reference. Credit managers need the ability to hold orders as leverage to force reluctant customers to pay immediately, or as leverage to negotiate a reasonable payment plan. Creditors can force a delinquent debtor into involuntary bankruptcy, but should do so only if it would be in their best interest to do so. If a creditor has a personal or inter-corporate guarantee covering a debtor's obligations, it has significant bargaining power. A creditor is in a better bargaining position if it provides a unique or proprietary product. If this is the case, the credit manager would be "unwise" not to use this leverage to secure payment from delinquent customers. When a customer has the creditor's merchandise and the creditor's money [in the form of unpaid invoices] the customer is in a relatively powerful position. Once a delinquent customer has paid the balance due, the balance of power shifts to the seller. Failing to react appropriately when a customer abuses your terms of sale changes the balance of power in favor of the customer in the short term and the long term.
2. For every inappropriate action on the part of a debtor [such as breaking payment commitments] there should be an equal and opposite reaction by trade creditors. Failing to react appropriately to abuses by customers invites even greater abuse.

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© 1995 Michael C. Dennis


Financial statement analysis is a tool most credit managers use in evaluating credit risk. Credit risk comes in two basic forms:

1. The risk that a customer's business will fail resulting in bad debt write offs for its creditors, and
2. The risk that the customer will pay slowly.

However, many credit managers perform financial statement analysis without understanding its limitations. These are some of the limiting factors credit managers must keep in mind:

1. Past financial performance, good or bad, is not necessarily a good predictor of what will happen with a customer in the future. The more out-of-date a customer's financial statements are, the less value they are to the credit department. Without the notes to the financial statements, credit managers cannot get a clear picture of the scope of the credit risk they are considering. Unless the customer financial statements are audited, there is no assurance they conform to generally accepted accounting principles. As a result, the statements may be misleading or even completely fraudulent.
2. To see the big picture, it is necessary to have at least three years of financial statements for comparison. Trends will only become apparent through comparative analysis.

In performing liquidity analysis, most credit managers use the current and/or quick ratio. The problem is that these two ratios only provide an estimate of a customer's liquidity--they are not accurate enough to be used to predict whether or not a customer is capable of paying trade creditors and your company in particular--on time (see Table 1).

A "standard" evaluation of liquidity using the current ratio and the quick ratio would indicate the customer in Table 1 has strong liquidity. In reality, this may or may not be the case. For example:  If the current portion of the long term debt were due before the A/R can be converted into cash, this customer could have a cash flow problem and might be unable to pay trade creditors.  This information is not available through standard ratio or financial statement analysis.

However, our hypothetical customer may have already taken steps to address this short-term liquidity problem. The customer might have arranged for a loan to factor its receivables. Unfortunately, this type of information is also not available or apparent using normal financial ratio analysis. Therefore, credit managers must ask more questions and to understand the terms their customer is giving to its customers as well as the terms it receives from its suppliers.

Referring back to Table 1, traditional ratio analysis would also suggest that because our hypothetical company has debt-to-equity ratio of 1 to 1 and is not highly leveraged, that the customer is a relatively good credit risk. This is not necessarily the case. Consider this example:  Assume a formidable, well-financed competitor, with a superior product, has just entered the marketplace. The fact that your customer is not highly leveraged does not necessarily mean your customer will remain profitable and viable, assume your customer is embroiled in a lawsuit involving product liability claims, environmental cleanup issues, deceptive advertising, or securities fraud. These are contingent liabilities. Contingent liabilities do not appear on the balance sheet. The moral is that just because a customer has a strong balance sheet does not mean selling to this customer on an open account is low risk. 

Referring back to the balance sheet in Table 1, let's assume your customer is the wholly owned subsidiary of another company. Suppose your customer's parent company is having financial difficulties, or is embroiled in a lawsuit involving large contingent liabilities. If the parent company decides to file for bankruptcy protection, in most cases its subsidiaries will also file at the same time. Again, traditional financial analysis does not give a clear picture of the risk involved in selling on an open account basis in this case. Even if the parent company is not considering filing for bankruptcy protection, the parent company could require its subsidiaries to upstream cash to the detriment of the suppliers of the subsidiary. 

Another possible problem not defined or described in financial statement analysis is that the due date on bank debt can be accelerated if the debtor fails to meet a loan covenant. If we assume our hypothetical customer is out of covenant now, the risk of business failure and bad-debt losses is unrelated to the insights and information gained through financial statement analysis. Here are a few ideas about financial statement analysis to keep in mind. As a customer's open account credit needs continue to grow, at some point it will become necessary to receive and evaluate a customer's financial statements to make an intelligent and informed decision about whether or not to extend the customer more open account credit. Once you have begun this process, be certain to request or require periodic updates. 

The bigger your concern, the more frequently you should review a customer's financial statements. Pay particular attention to the nature and scope of the audit performed on a customer's financial statements. Remember that internally prepared financial statements might not be worth the paper they're printed on. Be aware there is a limitation to comparing a customer's financial ratios to an industry norm. The limitation is the fact that industry norms are derived from companies willing or required to share financial information. Therefore, the best source of this information is publicly traded companies. So, if you're comparing a small, privately held customer's ratio to a public company's, the small company often suffers by comparison. 

Keep in mind the fact that financial statement analysis is just one factor credit managers use to evaluate risk. Despite its limitations, this type of analysis has an important role in helping credit managers to gauge and control risk.

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