History Won't Repeat Itself This Time

Many companies boast of their minimal bad debt write-offs as a measurement of successful credit management practices. However, our analyses of hundreds of receivables portfolios show that low bad debt write-offs AREN'T usually a result of good, strong credit policies or expert underwriting guidelines.

These results have historically been strong because of a once-growing economy where customers were making money and banks were lending cheap money so defaults were rare. Unfortunately, low bad debts have created a false sense of security and an ambivalence about the need for implementing disciplines in the credit approval/credit management areas. The results of this ambivalence are just starting to show now as creditors suffer through increasing credit losses.

Kamakura Corporation, the leading provider of risk management information, reports now that 12.1% of global public companies are now classified as "troubled". That's the worst performance since December, 2003. Even if your customers aren't public corporations, creditors should be alarmed at the growing risk within their receivables portfolio.

Just as too many people wait for a toothache to visit the dentist, creditors shouldn't be waiting for a big suprise bad debt loss to figure out that they need a strategy to know where their risks are and what they'll be in the future. The time is NOW to update your credit files and policies:

1) Send credit applications to all customers to renew their lines. Banks won't give you information if your customer applications were signed 5 years ago. Also, if your customer does get into trouble, you'll have contacts with other creditors to help you.

2) Update those bank references. When you don't have financial statements on customers (generally with at least 90% of the customers), this will be the next best tool to understand the company's cash flow position.

3) Monitor your customer base with the credit bureaus. D&B has a great product called DNBI that will keep constant alert on your customer risks and update you whenever there's a change. Experian has similiar services, as do several trade credit groups.

4) Establish a process for updating files and for managing the marginal credit risks: Don't leave this to chance or allow it go get done when people have the time. Make it a TOP priority to keep your credit files fresh and meaningful. You should be able to see companies deteriorate over time--very rarely does a company just fall apart overnight. When you see deteriorating credit quality, adjust your strategy by lowering lines, changing terms, discussing with Sales to adjust pricing, etc.

Your historically-low bad debt write-offs aren't likely to repeat in 2008 and beyond. The smart companies will be preparing NOW to prevent losses and improve their credit management capabilities.