Maintaining collections amid economic uncertainty is one of the hallmarks of a robust risk management program.

by Eric Ermantier, EDRIC Consulting

The essence of economic uncertainty is that a business manager hasn’t got a firm idea of what opportunities or reverses may await the business over the economic horizon. Absent such knowledge, common sense dictates making decisions and taking actions based on present circumstances and the best available information about future developments.

In terms of collection, this philosophy would probably accentuate the natural credit management tendency to “prevent hard and collect fast.”

Minimize Uncertainty to Control Risk

There is a difference between uncertainty that is generated by circumstances outside one’s control and uncertainty arising from lackadaisical or inadequate internal procedures.

The concept of “hard prevention” embraces eliminating deficiencies in internal data and systems. Measures to be applied include:

• maintaining the firm’s customer database with the most current available information;

• soliciting feedback from the sales department and providing them with necessary credit line and other information for prospects;

• exercising the utmost effort to resolve commercial litigations as soon as possible; and

• implementing realistic and competitive credit terms and strictly enforcing them

Expediting collections tends to have an overbearing advantage: realistic credit terms combined with positive collection activity minimizes deterioration of a commercial rela-tionship. In other words, the company continues to collect from satisfied customers rather than disenchanted debtors.

An adequately staffed and properly trained credit and collections department is essential to keeping trade receivables current. Management should examine the business’ profile to determine whether better results would be achieved with an in-house function or through outsourcing.

Risk vs. Uncertainty: Identifying and Coping

It would probably be advantageous to define a few basic aspects regarding the con-cepts of “risk” and “uncertainty.”

Are they the same thing? If not, what differentiates them and is one more dangerous than the other?

Risk is the consequence of uncertainty: uncertainty creates risk, rather than vice versa. Because the future is uncertain, management may either elect to reduce profits with hedging or other risk management programs or accept the possibility of a loss of unknown magnitude.

However, if the enterprise is able to give a dimension to uncertainty, it can evaluate risks created by its decisions and actions.

Uncertainty is not necessarily the same as ignorance. For example the market price, competition, regulatory and labor relations environments, etc. are uncertain, but this doesn’t mean that you don’t know anything about them.

The Future: How Much Can We Know?

It is uncommon to deal with uncertainty by submitting to it, but there are probably a few firms or managers that do business that way. For these, the future is described by a single value (e.g., the most probable, the central value, the average value) as if this value were certain. This kind of tunnel vision can lead to serious consequences if the expected value doesn’t materialize.

However, it is far more common to assemble what is known or can be estimated about the future and apply these data to0 mitigate uncertainty. Some of the ways in which this is commonly done are described in the following sections, in ascending order of complexity.

Subjective estimation: The single value described above may be arbitrarily adjusted to reflect the forecaster’s view of the future—optimistic or pessimistic. This becomes the foundation on which the firm’s risk management program is constructed.

Range of estimation: This method increases the precision and depth with which the firm addresses uncertainty. It is described within a range of possible values, all of which are assigned equal weight.

This increases the possibility that the actual course of future events will be captured somewhere in that range. Therefore, at least to some extent, risks arising from future uncertainty would be addressed in the firm’s risk management programs.

Weighted probabilities: The previous method contains a serious flaw; it treats the en-tire spectrum of possibilities as if they were equally likely to occur. In fact the extreme values have much less probability of being realized.

Eliminating these extremes from consideration, or only marginally regarding them, allows a sharper focus of the firm’s risk management on the more likely courses of future development. These several cases can be analyzed in greater depth.

Revisiting Collections

Taking all this theory in consideration, let’s revisit the concept of hard prevention and fast collection.

Maintaining a current customer database: Time is the enemy of the credit depart-ment’s customer database. Customers are moving fast, people change, and contacts that originally prevailed may disappear in a few weeks or months.

Moreover, the person who originates the order is not the person who approves pay-ment and that person, in turn, is not the party that executes the check or funds transfer. It’s necessary to know “who does what and when” in the customer’s office.

Deploy resources in order to maintain the customer database, so that the credit manager or representative is “up close and personal” with customers, and, thus, in the best position to expedite collections.

If internal resources are not enough, augment them or outsource the maintenance procedure. It is absolutely the cornerstone of a successful credit risk management program.

Involving the sales department: Since sales representatives are on the front line, they represent the first step in the credit management process. The sales force is well located in the economic chain discover the identities and natures of the people and firms with which they deal.

When a representative receives an order whether from a new or existing customer, he should use the opportunity to update the firm’s information about the customer as far as possible.

Information (i.e., financial statement, credit reports, etc.) is a key commodity in terms of preventing collection situations from arising; as gained, it should be broadly disseminated internally.

Sales representatives should also be paid commissions calculated on a paid invoice basis, so that they would identify with the desirability of getting paid at least as much as “making the sale.

Solve commercial litigations quickly: If they are not resolved early enough, collec-tions often deteriorate into litigation. The ideal approach would be to avoid litigations by being irreproachable.

Being “irreproachable” means that, in the process of selling, the firm closes all possible doors the customer might use to claim that terms of sale were not completely fulfilled.

For example, there can be no litigation about the price if it is perfectly detailed in the contract, including discounts, terms of payment, etc.

Too often, the salesman approaches the customer, agrees on a price, but doesn’t settle terms of payment. This is a wide open door for the customer to assert he will pay later than he is supposed to.

Establish, implement and observe terms and conditions of trade: Terms and condi-tions of trade are not simply intended to be boilerplate on your invoices and contracts.

You may feel that generally nobody reads them or take them as seriously as they should be taken. In 90 percent of the cases this is true, but the customer with larceny in his heart will study deep inside all your terms and conditions, to find their weaknesses.

The firm has to know to whom, what and how much it is selling in any given transaction. Detailing these aspects in terms and conditions should eliminate virtually all uncertainty as to the responsibilities of the counterparties.

Collect from customers rather than debtors: Initiating collection pressure on cus-tomers with overdue accounts increases the odds of collection vs. waiting until the sit-uation has deteriorated to the point at which collection action becomes necessary.

There is nothing negative involved with call a customer to remind it that a particular invoice or installment is coming due and that discounts or other benefits may be lost if it not paid on time. In fact, such an approach would probably go a long way to cement relationships between a firm and its customers, so that few, if any, ever slip into “debtor” status.

Provide adequate resources for credit and collections: Staffing the collection depart-ment has not historically been a top priority for general management. However, it is a prerequisite in order to achieve the goals that collection implies, particularly in a risky and uncertain economic context.

Collection is a “people” job and the quality of the firm’s collection program will de-pend on the quality of its people.

People who collect must do the work without feeling “it’s just a job.” Skilled col-lection specialists may actually approach their duties as a competitive game, so that bad debt and turnover reduction become a challenging goal that they constantly strive to improve.

Training Equals Earning

“Collection” is a synonym for “communication” and communication skills are not equally given to all persons. For that reason, it may be desirable to train selected collec-tion specialists on job-related skills.

Training does not reinvent the trainee. However, it may bring more self confidence, it will help identify prospective leaders and will a team where there was just a loose association.

Use a specialist for such training. The individual chosen should come from outside the company rather, so that he will have a fresh prospective on problems and solutions.

Use of Independent Contractors

It may be possible either to staff the firm’s in-house collection department with contract specialists or to outsource the entire function to a third-party provider.

Specialized contract collectors may be incorporated into the firm’s collection func-tion. These contract employees become virtually fully integrated, working with the firm’s systems and procedures.

This approach provides flexibility benefits vs. hiring employees, especially in an uncertain context, because the firm avoids having to provide for the sometimes substantial leaving benefits that would result from reorganization.

Our firm has a lot of experience in developing solutions involving such in-house con-tractors. Our clients have been generally well-pleased with the results achieved from such a program.

Outsourcing is another way of improving your collection. Under this alternative, additional staff will not join the firm’s function; instead, customer accounts are trans-ferred to a specialized collections firm. In order to make this method work, however, it’s necessary to establish some ground rules with the contractor.

The contractor should be in continuous contact with the firm, given the importance of the collection function and the already-noted fluidity of contacts and relationships between customer and vendor.

In order to accomplish this, a permanent reporting format has to be developed and observed. Providing the contractor with the firm’s own internal communications tools would also be useful: in terms of keeping in touch with the results of its efforts, while continuously communicating the necessary information for it to do the job.

The selected contractor has to provide the technical possibility for maintaining control of collection efforts. In the ordinary course of events, the contractor will perform most of these duties but, as we say in French, “Whoever is able to do more, can also do less.”

Adaptability is the main consideration in terms of any collection program. It is the quality that will allow the firm to survive through uncertainty and risk.