The Good News is that you got the order, the Bad News is that you got the order
By Steven Kozack

Scenario:

A new customer has given us a purchase order for $1.5 million. This is good news and bad news. The customer wants us to ship about $200,000 dollar per month on Net 30 day terms. The company in question is not creditworthy for the full $1.5 million or anything close to that amount. [I estimate the company in question might qualify for a $100,000 line with us under normal circumstances.]

We definitely could use the business, but the profit margin is thin, and in order to make this sale as profitable as possible our manufacturing department wants to build one-third of the product at a time. What would you suggest?

Answer:

You said it very well...the good news is that you got the order and the bad news is you got the order. No company wants to walk away from a $200,000 a month in sales, but the basic fact is that this customer does not qualify for the credit limit they need --- and the plan to manufacture $500,000 of this order at a time complicates the problem even further. You should give serious consideration to some alternatives such as:

• Requiring a substantial partial payment in advance.

• Factoring the receivable [assuming you can find a factor willing to accept the risk --- and assuming you have a large enough profit margin in the sale to pay the factor and still show a profit.

• Asking the customer to arrange for a standby letter of credit to be issued in your favor.

• Requesting security in the form of pledged collateral... and then perfecting your security interest in the pledged assets before shipping.

• If open account terms are contemplated, shorten the terms of sale to 15 days to eliminate the possibility of two shipments being sent to the customer in question before a payment for the first one is received.

Some additional notes of caution:

• Try to convince your manufacturing department not to build ahead. Why? Because the more your company has invested in the project, the harder it is to walk away if things go bad.

• If the product the customer has ordered has a long manufacturing cycle or [worse] is a "custom build", give even more serious consideration to requiring payment in advance, or as an alternative requiring a letter of credit.

One final thought: Some credit related issues need to be reviewed with senior management. This seems like one of them. If senior management wants this deal and is willing to accept all of the risk if things do go wrong, the credit manager is "off the hook."

Scenario:

A new account has requested a $50,000 credit limit. They have been in business two years, reported a loss in the first year, increased sales by more than 80% in the second year and reported a small profit. This is a partnership. The credit report shows one vendor has placed the account for collection and two lawsuits have been filed by what appear to be trade creditors that never got paid...and the company moved in the last six months. Is this an account we want to extend open account credit to?

Answer:

I am not trying to sidestep the question, but a comprehensive analysis requires credit professionals to look at a large number of factors before making a credit decision. The credit department does not want to be accused of being short-sighted, or failing to perform due diligence before making a decision. Other factors needed to make this decision include:

• The applicant's credit rating

• A bank rating, average balance, current balance, and any history of NSFs

• Whether or not the bank relationship involves a line of credit

• Details about the applicant's financial condition

• Manner in which the applicant normally pays creditors, and the manner in which the company is currently paying its creditors

• High credit with other creditors in the last twelve months

• Your company's profit margin, and your loss history this year

• Your company's sensitivity to credit risk and credit losses

• The size of your bad debt reserve

Based on the information you provided, offering $50,000 to this applicant is going to be an up hill battle.