Credit Analysis To Promote Successful Debt Collection

No one wants to think about future debt collection issues when taking on new customers, but in today’s economy, it would be foolish not to approach credit decisions with some caution. Accounts receivable represent one of a company’s biggest assets. In order to prevent the need for future debt collections, it is up to the credit executive to develop detailed and specific new customer account parameters.

Evaluate New Customers

When a new customer is landed, and the credit department sets up the account, the credit department must have a specific procedure to follow. Consistency of the data base will make everyone’s jobs a lot easier as the customer relationship moves forward. Ideally, the new account should detail accurate name and address information. Many credit departments assign an account number to each customer. This number may be based upon a DUNS number, social security number, federal tax ID number, or some other numbering system specific to the company. Many credit departments have a predefined system in place for acceptance or denial of credit for new customers. The credit policy can be very helpful because it takes a lot of the subjectivity out of credit decision making.

In most cases, sales personnel are the first to make contact with a new customer. In addition, they are typically the company representatives who make the most ongoing contacts with customers. Therefore, sales personnel often are an excellent conduit for collection of credit information. Not everyone is well-suited to participate in credit or collection activities. However, all sales personnel must be trained to understand the important role they can play in the credit analysis and extension processes.

In some companies, sales personnel will provide new customers with a financial statement form to fill out and return directly to the credit department. Some customers, however, will prefer to give the completed form to the sales person and have him or her turn it into the credit department. It is often possible for sales personnel to look and listen when making sales calls and provide the credit department with important information about the look of the business, the location, competition, management, brands and products being sold, etc. In the best-case scenario, a cooperative attitude between the credit department and sales personnel is the ideal.

Obviously, the best source of information about a new customer is the customer. Whoever makes direct contact with the customer, whether it is sales or credit personnel, will have the opportunity to ask for and hopefully obtain financial data as well as references from banks and other businesses with which the potential customer already does business. How cooperative the potential customer is when providing credit analysis information may signal future customer relations. The more forthcoming the customer is the better.

Clearly, making credit decisions based upon sound customer information will have a positive impact on prevention of future debt collections. Minimizing future debt collection issues is a goal of every credit department. Taking the time to examine new customers before they place their first order will lead to fewer accounts receivable collections down the road. However, if debt collections become a problem, hiring a collection agency can be a good move.

Credit Application Development

One way to prevent future debt collection issues is to develop a credit application that collects salient and specific information about the potential new customer. This section will focus on development of a credit application which will gather all necessary information.

The best way to gather credit information about a potential customer is through a credit application. The standardized nature of a credit application makes it possible to collect the same type of data about every new customer. This consistency will promote consistency in credit decisions, and it will also be helpful in terms of the quality of your database.

Below are key data items which should be included in your credit application:

Business general information

• Business name including any other DBA names used to obtain credit.
• Telephone and fax numbers
• E-mail addresses
• Federal Tax ID Number
• Addresses
• Description of what the business does

Details about business entity

• Is the business exempt from sales tax? If yes, submit a copy of the tax exempt certificate.
• Number of years in business. Number of years in business at current address.
• Does the business own or rent its current location?
• Credit references.
  • Bank names, addresses, telephone numbers, account names and numbers, officers familiar with the accounts
  • Suppliers names, addresses and telephone numbers
  • Statements for credit cards used by the business
  • A list of customers
  • A copy of the most up-to-date financial statements.
• Are there any liens or security interests attached to business accounts receivable, inventory or equipment? If yes, secured parties’ names, addresses and telephone numbers.
• Does the business have any outstanding loans? If yes, names of creditors, names of loan officers, types of loans, original loan amount, present loan balance, amount of monthly payments and any collateral listed.

Owner information

• If the business is a sole proprietorship:
  • Name of sole proprietor
  • Social security number of sole proprietor
  • Home address
  • Home telephone number and e-mail address
• If the business is a partnership:
  • Names of partners
  • Social security numbers of partners
  • Home addresses of partners
  • Telephone numbers and e-mail addresses of partners
• If the business is a corporation (or LLC):
  • Date of incorporation
  • State in which incorporation occurred
  • Names of officers
  • Names of Board of Directors

Amount of credit the applicant would like to be extended per month.

Authorization from applicant

• To allow credit department to check credit history and references provided by applicant.
• To allow release of information to credit department by other creditors relating to applicant’s credit history.

Terms of credit extension

1. Customer agrees to abide by all payment terms set forth on future invoices
2. Customer agrees to pay all state sales taxes
3. Customer agrees to all agreed upon interest rates
4. Customer agrees to pay all collection costs incurred
5. Customer agrees to abide by all governing laws

Personal Guarantees (if applicable)

Not every business requires a personal guarantee on credit extended. If a personal guarantee is required, terms similar to those outlined above would be appropriate relating specifically to the guarantor. A signature by the guarantor on the credit application would also be necessary.

Signature of applicant attesting to the truth and accuracy of the application

Gathering detailed contact and financial information about potential new customers will go a long way in preventing future debt collections. In addition, should an account go delinquent, having all the information from the credit application on hand will make contacting the debtor and pursuing payment much easier. One big challenge in the debt collection arena can be locating the debtor. Accurate contact information is an essential requirement for successful debt collections. If a time comes when accounts receivable collections are out of control, hiring a collection agency might be a way to increase collections success.

Credit References

The more information that is collected during the credit analysis phase of a new customer relationship, the less likely future debt collection issues will arise. Of course, the information collected must be accurate and meaningful to the analysis process. This section will focus on credit references.

When a credit department is collecting information for its credit analysis of a potential new customer, one key area is to ask for credit references. Below is a list of information you need to obtain from each credit reference:

• The name and address of the potential customer you are requesting the credit information about.
• What is the largest amount of credit extended to the potential new customer?
• How long has the credit reference been in a business relationship with the potential new customer?
• How much does the potential new customer currently owe the credit reference?
• How much, if any, is delinquent?
• Over time, what has the payment pattern been? On time, past due, etc.
• What are the payment terms agreed to with the potential new customer?
• Did the credit reference obtain a personal guarantee or security agreement from the potential new customer?
• Has the potential new customer remitted any NSF checks for payment?

One thing to remember when checking references for a potential new customer is that the customer will probably not give you references which will reflect poorly on their business. Therefore, it is always a good idea to go beyond the references provided by the customer and check a few references that you come up with on your own. Examples of additional references to check might be other companies within your industry which do business with the potential customer, or other product lines sold by the potential new customer.

It is usually prudent to base credit decisions on facts, not feelings. However, the character of a potential customer is still important. The best way to judge character in the credit decision arena is to look at the reputation of the potential new customer within your industry and to carefully evaluate the references you are able to obtain. These two things will usually give you a good idea of the integrity of the potential new customer.

When you are designing your credit reference form, the simpler and easier it is to complete, the more likely it is that you will receive the reference. If you are asking the person to mail the reference to you, include a self addressed stamped envelope. In today’s high-tech world, an online reference form which can be filled in online and submitted electronically is a plus. The easier you make the process the better the response rate.
If credit references are collected by telephone, be sure to take detailed notes on all topics covered. Take note of the person’s name and title that provided the reference as well as the date of the conversation.

Collection agencies do not typically get involved in the credit department’s credit analysis or decision making processes. However, it is true that the more you know about a potential customer, the better. If it turns out that debt collection becomes a reality with a customer, all the information collected during the credit analysis may prove helpful. Sometimes just being able to find a debtor is difficult, and the contact information in the credit analysis may enable location and possible payment. Accounts receivable collections are important in any company. Collection agencies are experts in debt collections, and they have the resources necessary to locate and collect even from debtors who have disappeared.

Financial Statements and Credit Reports

Putting the time and effort to do thorough credit analyses will lead to a better customer base and fewer debt collection issues in the future. This section will focus on financial statements and credit reports.

When requesting financial statements from a potential new customer, it is a good idea to ask for ending balance sheets and income statements for the last two fiscal years. Generally, a customer that is forthcoming with the requested financial information will be treated more favorably in the credit decision. The reason why you want to look at financial statements is to be able to define the risk associated with extending credit to the customer. The higher the dollar amount of credit extended, the more financial data you may want to request and examine. It may be valuable to compare the potential customer’s financial data to other similar customers to identify strengths or weaknesses relative to the industry.

Under no circumstances should you ever accept estimated financial statements from a potential new customer. Always require the financial statements be signed and dated by the owner. If the statements are submitted by an accountant, require the accountant to sign off on the statements on the accountant’s stationary. In addition, require that the potential new customer sign off on what is submitted by the accountant. If the statements are received by mail, save the envelope in which the statements were sent because it shows the date stamped by the post office. Saving the envelope can become important if credit is extended based upon fraudulent information. The envelope can prove that the fraudulent information was sent via the USPS.

The credit analysis for a potential new customer should include requesting credit reports. There are four categories of credit information available for businesses:

• Business Information Report by Dun & Bradstreet.
• Payment history reports such as those provided by the National Association of Credit Management, Dun & Bradstreet, Experian and Reimer Reporting.
• Credit agency reports specialized to a particular industry.
• Trade group interchange reports.

From these four credit information sources, the following information can be collected:

• Contact information associated with the potential new customer (check the information provided by the customer with the information obtained on the credit reports). This information would include the business name, address, and telephone number, the name of the owner or CEO, and the Standard Industrial Classification code. The SIC code can be helpful if the credit department has a customer classification system in its database.
• Agency rating
• Agency credit line dollar amount recommendation
• Payment history
• Financial data (hard data with trends identified)
• Banking data
• Historical information about owner(s)
• Information about business operations

The above information provided in credit reports can be combined with the financial data submitted by the potential new customer. These data together should provide the credit department with a wealth of information which will help them assess the credit risk posed by the new customer. Solid credit decisions will be worth the time and effort required to collect and analyze new customer financial data.

Collection agencies are usually not involved in a credit department’s decision of whether or not to extend credit to a potential new customer. Collection issues can arise for a variety of reasons. In today’s tough economic times, many companies are just barely scraping by. When cash flow slows way down, this can make it nearly impossible for companies to make payments to their vendors, and the debt collection process begins. When collection agencies get involved in accounts receivable collections, the data gathered during the original credit analysis can come in very handy. Knowing accurate contact and banking information can significantly increase a collection agency’s chances of successful debt collections. The time taken to gather complete and accurate credit analysis information is definitely time well spent.

Credit Decision

All credit decisions made by a credit department can lead to future debt collection challenges. The key is to put enough time and energy into the credit analysis to minimize the potential for future delinquent accounts receivable. This section will focus on determining and communicating the credit decision to a new customer.

Every company involved in extending credit to customers needs to have a clearly defined credit strategy for the credit department to follow. In most cases, this strategy will be the credit policy which provides the basis for consistent credit decisions. Credit limits are necessary because they limit the company’s potential for loss. Each customer must be evaluated because circumstances are so unique to each customer’s business situation. No two customers are alike due to product, distribution, and market differences.

When making a credit decision for a new customer, the potential ongoing relationship must be evaluated. If the customer is a one-time sale customer, credit should not usually be extended. Instead, less desirable terms such as cash on delivery or cash in advance are appropriate. Customers who plan to buy now and increasingly into the future must supply the credit department with all requested information so that they can establish adequate credit with your company to support the long-term relationship.

When conducting the credit analysis of a potential new customer, the evaluative process can not be so long that the customer ends up going elsewhere. In addition, the cost of conducting the credit analysis must be worth it given the potential sales of the new customer. Calling references, requesting credit reports, etc. cost money. If the potential new sales from the customer are very small, it may not be worthwhile to go forward with the credit analysis or the customer.

Many factors can affect the credit decision. If demand exceeds supply at your company, then extend credit only to the lowest risk customers. If your company has a large stock of inventory, credit terms may be more lenient in an effort to clear out excess inventory. If the profit margin on a product is very high, credit terms may be more lenient in an effort to encourage the purchase. If the staffing is very limited in the credit and collection department, terms may be more lenient in an effort to get credit analyses done on a timely basis.

Some companies have what is called “Automatic approval” for orders totaling an amount less than a predetermined amount. In this case, the risk is considered to be low enough not to warrant the cost of a full-blown analysis. Other companies base automatic credit approval for small orders on the current credit reporting agency ratings.

When the order amount is above the limit for automatic approval, typically the credit department will require some level of analysis which might include: the new customer application, current credit agency reports and ratings, most recent financial statements, industry and supplier references, current bank information, and phone calls or personal visits to the prospective customer’s business.

Once the credit decision has been made, the new customer must be told the results. One way to deliver the decision is to make a personal visit to the customer. The advantage of this approach is that it gives you the opportunity to talk to the customer and begin to develop a relationship with the customer. It also gives you the chance to explain the credit policy and terms of the credit decision to the customer. If the credit decision is not as favorable as the customer may have hoped, it gives you the opportunity to coach the customer on ways to increase the credit limit.

The disadvantage of delivering the credit decision in person is if the decision is not what the customer wants to hear. In this case, the customer may be insulted by the lack of credit extended, and may feel restricted in his ability to place large orders in the future. The customer may not feel goodwill towards your company. If this situation occurs, being there in person may give you a chance to work out some of the issues and eventually promote goodwill.

Collection agencies are not involved in making credit decisions for potential new customers. Debt collection issues usually arise when credit decisions have been more lenient than perhaps they should have been for a particular customer. When debt collectors become involved with a customer, usually the credit line has been frozen and all future shipments and orders are placed on hold. To reestablish credit, delinquent customers must bring all accounts receivable collections to zero, and a new credit analysis must be conducted. It is easy to see why a credit department would be hesitant to begin extending credit again to a customer who has been significantly delinquent in the past. Something must be drastically different to cause a reestablishment of credit. Collection agencies and debt collectors through their collections work may be able to determine if the circumstances have changed in a positive way to warrant credit extension reconsideration. Extreme caution in this situation is definitely appropriate.

Purchase Orders

Debt collection is not usually considered when performing credit analysis; however, insufficient credit analysis can eventually lead to accounts receivable collections. This section will focus on what should be included in the customer’s purchase order.

Once credit is extended to a new customer, the relationship truly begins once the first purchase order is received from the customer. For the seller to maintain its profit margins on its products, care must be taken by the seller to follow the purchase order instructions and procedures to the letter. Most deductions from customers result from the seller not following the purchase order instructions correctly which ultimately eats into the profit margin attached to the product sold. In the case where the seller does not agree with the purchase order, it is up to the seller to amend the purchase order in writing to allow for a variance from the original order before the order is filled.

Every order by a customer must be confirmed with a purchase order. Never proceed with filling an order without a purchase order in hand and an assigned purchase order number. If you allow your customers to place orders without a purchase order, you open up the company to being manipulated by the customers with last minute changes to orders and an overall lack of control over the order and how it proceeds through the internal company systems. In general whenever there is an order change, the change must be requested in writing and confirmation of the change with the customer’s receiving department should be received to avoid problems upon delivery.

Below are things to look for in your customer’s purchase orders. These items will help the seller fill orders correctly and maintain profit margins and customer relations.

• The most important thing to check is that the information on the customer’s purchase order exactly matches the order that is ultimately entered into your company’s computer database. The reason why this is so critical is that deductions usually result from these inconsistencies. Whenever possible:
  • Customer name
  • Customer address
  • Customer city, state and zip code
  • The terms and conditions of the sale
  • A line-by-line itemization of the order by product
  • The pricing of the order, by item and in total
  • Billing information
  • Shipping instructions
  • Purchase order number
  • Department information
  • Shipping dates
  • Cancellation dates
  • Promotional or advertising information
  • Any special instructions
• Signature of the buyer
• Instructions about invoices
• Any incentive program information that will affect billing (for example, quantity discounts).
• Is the order quantity within the credit limit current balance available?

Collection agencies are not usually too concerned about purchase orders. However, because deductions can be such a huge problem for sellers these days, collection agencies may become involved in attempting to collect on deductions taken in error. These debt collections can be very difficult to collect for in-house debt collectors because the company may have a desire to maintain good customer relations. In this situation, calling in an independent third party to pursue the debt collection may be a good idea. Collection agencies are experts in accounts receivable collections, and they know what strategies work the best for different types of debt collections. Because they typically work on a contingency basis, their fees are only paid if the collection is successful.

Identifying A Fraudulent Credit Applicant

The need for debt collection can be minimized by proper credit analysis of potential new customers. It is important to examine each new potential customer carefully enough to ascertain the credit risk they might represent down the road. This section will focus on identifying a fraudulent credit applicant.

Sometimes when a new customer provides requested information for the credit analysis, something just doesn’t seem quite right. If the credit department gets this sense about a potential new customer, extra care should be taken in the analysis process.

Here are some things to look for in the credit application which might point towards a fraudulent applicant:

• A company billing address or shipping address that somehow seems familiar as a suspicious business.
• Owner names that seem familiar as having been associated with a suspicious business.
• Compare the company name, address, telephone number and owner’s name across the various credit sources you have collected such as the credit application, credit reports, banking information and references. Discrepancies might indicate a suspicious business.
• Be wary if you receive an unusually large opening order which seems inconsistent with information you know about the customer’s business and what a typical order should be.
• Be wary if the billing address and the shipping address are different for a small company.
• Be wary of reference names that seem familiar as having been associated with a suspicious business.
• Be wary if the applicant provides several references that you have no previous experience with. Oftentimes, new customers will provide references that you have received from other customers.

After the credit analysis is complete, if you feel suspicious that the applicant might not be above board, what should the credit department do? The first thing to do is stop and think. Accusing a company of applying for credit fraudulently is a serious thing. If you are wrong, the potential new customer could be lost, and your company’s reputation may be damaged. Look to your credit department and review the facts and suspicions you have with someone who is objective. See if they come to the same conclusion you did without leading them there.

If the suspicions continue, the next step is to contact the unfamiliar references. When making the calls, take detailed notes. Listen to how they identify themselves and their business. Try to give them as little information about your company as possible. Where possible, try to contact the various unfamiliar references over a few days. If the application is fraudulent, most likely all the unfamiliar references are one person. The key is to not let them become aware of your company’s suspicions relative to the applicant.

Be sure to contact listed references that you are familiar with and have a trust in. Talk to these references about the facts and suspicions you have regarding the applicant. Ask for their honest opinion and reference for the applicant. Listen carefully to any advice or help they might offer.

If, in the end, the suspicions about the applicant continue, the next step is to get professional help. There are two sources for this help: The National Association of Credit Management and the Federal Bureau of Investigation.

Collection agencies are sometimes hired by companies to help track down fraudulent customers. These customers typically try to disappear and avoid paying for orders that they have received. Frequently, their businesses have failed and they have abandoned the enterprise in its entirety. Collection agencies are very good at finding debtors who have flown the coop. They are experts at skip tracing and other location strategies, and can sometimes find people when everyone else has come up empty. The debt collection process in these cases can be very difficult. However, if the debtor still has assets, sometimes debt collection is possible because collection agencies are able to negotiate payment terms over a period of time. Because professional debt collectors are experts in commercial collections, they can come up with creative ways to obtain payment from debtors. The key is to not wait too long once an account is past due. The older the debt is the less likely it is to be collectible.