Balancing Act

Excerpt from: {see} Digital Magazine - Issue #5
Published: January 8, 2009


How Balance Between Credit Originations and Collections Keeps Everything at an Even Keel During Economic Crisis

Remember how much fun the seesaw was when you were a kid? Playgrounds have become more high-tech than when most of us were kids, but the seesaw still seems to draw in the kids of today. There's something about the challenge of the counterbalance between you and your partner that can bring a smile to the face of anyone. Balance, it seems, appeals to us all.

Only you can determine your tolerance for risk, but for most businesses it has been too high when it comes to extending credit. That's not a knock on you, by the way, every Thom McCann's Shoes, Dick's Sporting Goods and Harry & David's Gifts has been passing out credit like it was candy over the past 15 years. Suffice it to say, you've got plenty of company. There is a reason for this, Barry Connelly points out, "For the most part, consumer credit in the United States grew rapidly through the second half of the 20th Century - aided greatly by the increased availability of consumer credit data and technology." Further, Connelly adds "It wasn't long before automobile manufacturers and retailers realized that they were making better margins and greater profit from the credit contract with the consumer than they did from the sale of cars or merchandise."

Now is the time to brush up on the fundamentals of risk management and go back to basics. "It's a proven fact that if lenders and investors stick to the tried and true principles of granting credit for a sound purpose to consumers with good payment history, everyone will be a winner," says Connelly. "But," he cautions, "First we have to recover from a time when credit policies have been pretty lax in some sectors."

Ready to go with a winning strategy? Here's what you can do today:

  1. Compare multiple sources of data when deciding on credit originationsCredit information is fundamental in a credit transaction. It helps you make difficult decisions that are crucial to your business. But credit information is not always perfect and does not always show you a consumer's entire financial picture. Checking multiple sources insures you against any errors and can give you information that cannot be found on a credit report. During tough times, every decision is critical to the success of your business so deciding to get all the facts before you authorize funding can be the best decision you make.
  2. Cooperate with other businesses in your area
    These difficult times can create the opportunity for crooks to take advantage of small businesses that have become more desperate for new customers. Even the most conservative businesses can fall victim to scams but con artists often hit more than one business in an area. So, now is the best time to reach out to other businesses and share experiences with fraud. Local business groups that run businesses like yours have experiences and practices that can save everyone in your community from the costs of fraud.
  3. Implement Your Red Flags Program
    This one's not optional; any business offering credit has to comply with the federal government's Identity Theft rules for detecting and reporting identity thieves. Businesses have until May 1, 2009 to implement their "Red Flags" Identity Theft Prevention Program. You really should need little "encouragement" from the government - all you need is one number: $52 Billion. According to the FTC, that's the total 2007 losses for businesses and individuals due to identity theft. If you're behind on your planning, the good folks at {SEE} magazine have got you covered. There is a breakdown of what you need to do to get Red Flags compliant in A Common Sense Approach to Red Flags for Small Businesses in this issue.

When it comes to credit, American consumers and businesses have been playing a dangerous game of seesaw, adding pound after pound to the consumer side of the seesaw by promoting credit for every purchase. Now, it seems the game is up and our country's economy is in financial crisis and credit is unavailable to most consumers. Business owners/managers are now challenged with how to effectively extend new credit to facilitate new business in the face of a profound collapse in spending while managing the significant collection challenges and default risks of their current accounts. It's time to reevaluate the balance between credit and collections.

For many, balance can only come with the development of more restrictive credit policies coupled with more flexible and efficient collections procedures. We spoke with credit information expert Barry Connelly, former president of the CDIA (Consumer Data Industry Association) about credit originations. To complement Mr. Connelly's expertise, we also spoke to Michelle Dunn, a nationally recognized expert in credit and debt collections. In addition to spending many years in the industry, she is author of several books, websites and blogs on collections and the steps you can take to get your originations and collections into balance starting today.

The other side of the coin is your collection practices. Instinctively, you may think a time of economic crisis is the best time to ramp up your collections efforts and to play hardball with customers that owe you money. With regard to ramping up your collections efforts, no one would disagree that moving employees focused on credit originations over to the collections side of the business is a good idea. However, before you play hardball with your hard-earned customers, think about the following alternative.

Al's Tire Warehouse and Zed's Tire Emporium both have five delinquent accounts. Al takes the hardball approach with all five. He recoups his money from three of the five and the other two don't have the money, thus he writes them off. It's not the most pleasant way to do things, but he gets a good amount of his money back. Zed, on the other hand, works with his delinquent accounts to set up installment plans that meet his business goals while fitting the consumer's current budget. In time he recoups his money from all five accounts and maintains the business relationship with all five accounts.

So there's a trade-off. Al got his money faster and even though he got less of it (since only three accounts paid up) he didn't have to go to the expense of working with the customers to set up installments, so he and Zed came out roughly equal, right? Wrong. Zed came out with five indebted customers, Al will be lucky to get repeat or referral business from any of the five. During these times of reduced spending and low consumer confidence, customer retention and referrals can make or break your business. It will cost Al more money to find new customers to replace the ones he lost than it cost Zed to create and manage his payment plan.

So you can {SEE} how collections can balance out originations, even in a tough economy? Here are some simple steps you can take:

  1. Write up a Collection Letter Progression
    The first step in collections is typically a letter notifying the customer that they are behind in payment. If you're like most people, you didn't get into business to become a bill collector and you dislike dealing with this part of the business. That's all the more reason to formalize your process with a progression of letter templates ready for use when a customer does not make payment(s). First, set up a timeline for collections letters. You'll want to send one immediately after a missed payment, gently reminding the customer of the account being overdue progressing to a more aggressive message in subsequent letters. Write three letters and set your calendar to trigger sending these letters as the delinquency progresses. Each letter should indicate an action that will be taken by a specific deadline. Offer no guarantee, but indicate other installment plans may be available if current terms cannot be met. In certain cases, this may be the only way to save the account from default.
  2. Run credit reports on delinquent accounts
    It's a good idea to run a credit report on any customer who is past due on an account to see if the level of credit risk has changed since origination. Even if you ran a credit report when you opened the account 6 months ago, the risk of default may have changed. If the customer's credit report is spotless, you may want to check for any errors or address discrepancies that would cause the customer to do something as "out of character" as miss a payment. On the other hand, if a customer hasn't paid a bill in the six months since becoming your customer you know you might want to get in touch with a collections agency immediately.
  3. If you work with a collections agency, periodically review strategy with your contact there.
    The balanced approach can only be successful if everyone involved in maintaining that balance understands your objectives. If you're not taking on as many new accounts and your collections agency is aggressively going after current customers you may be driving hard-earned business away.

As with most things in business, balancing originations and collections is about judgment. Only you can decide the right recipe of risk vs. reward for your particular business. One thing is for sure, though: whatever keeps things in balance, be sure to monitor that balance. Make sure that everyone on both sides of the seesaw is working together and the whole playground will prosper.

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