How to Extend, How to Collect

A Special Series from North American Wholesale Lumber Association

Industry in the United States is driven by the granting and receiving of credit. By offering credit to your customers, you’re essentially investing in their company.

There are three main components of good credit policies: analysis, terms and collections—but that’s where things get tricky. If you don’t have the proper processes and procedures in place to extend credit and, later, collect on those accounts, your company will quickly find itself in peril. Extending and collecting credit effectively makes your cash flow.

Analyzing Credit
It’s great to have customers, but it’s important to have the right customers. “Just because somebody wants to buy something doesn’t mean you should sell it to them,” says Steve Rhone, president of Weston Forest. In other words, you need to make sure you’re making good choices about who to do business with. There are a few ways to make that determination. 

Many companies use third-party services to receive financial information on a potential customer. Tri-State Forest Products, for example, uses Dun & Bradstreet and Blue Book Services. When we get an application from a new customer, we check with Blue Book and/or D&B. They provide credit history so we can see if they are good pay or slow pay, if there are any trends we can observe, and if they are getting better or worse.” 

In addition to third-party credit checks, many companies require customers to submit credit references. A company’s credit references often provide more current feedback. At Tri-State Forest Products, long-term customers versus one-time sales are also a consideration.

Weston Forest also uses outside help to determine who to sell to. After the company determines a customer’s credit worthiness, Rhone says, a third-party insurance company—in this case, Euler Hermes—verifies its position. “They have an extensive database of active customers, and they are proactive in letting us know when we are exposed to somebody who is risky,” he says.

Defining Terms
Once you’ve decided to extend credit to a company, you must establish the terms of that agreement. This includes the credit period as well as any discounts you may decide to provide in a certain period. For example, you might offer a customer a 1% discount if they pay within the first 10 days. Otherwise, their bill is due in 30 days. The terms of sale would then look like this: 1/10, net 30. 

Once the terms are agreed to, it’s important to have a policy in place to inform customers of their balances. This is often performed monthly. Pricing and terms go hand in hand.

Collecting on Accounts
Receiving the money you’re owed is crucial to keep your business afloat. There are two main approaches to collections: the average collection period (ACP) and the accounts receivable aging schedule. The ACP formula identifies how many days it takes to collect: 

Days in Period x Average Accounts Receivable ÷ Net Credit Sales = Days to Collection

An aging schedule lets you see what percentages of accounts are delinquent or late. The schedule below is for a company with $200,000 in receivables. 

Age of Account     Amount       % Total Value of Receivables
    0-10 days            $40,000              20%
   11-30 days            $80,000              40%
   31-60 days            $40,000              20%
   61-90 days            $20,000              10%
   Over 90 days         $20,000              10%
                                 $200,000            100%

Collection policies vary from company to company, but it’s important to have a strong grasp on what you’re owed and a clear policy on when to escalate the collection process. 

At the 60-day mark is when Tri-State Forest Products ramps up the collections efforts to bring in those   receivables. We don’t have a lot of bad debt out there, but we do have some we have to work harder on the collect. For the most part, collections are not a typical problem. There are just times where you have to push a little harder. 

We also apply service charges for past due accounts and place accounts on credit hold so accounts with past due balances aren’t allowed to escalate without manual overrides. We will also leverage new sales to collect past balances.

– Rob Latham is vice president of Tri-State Forest Products, Springfield, Oh., and secretary/treasurer of NAWLA.

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