I have a client that has 500 active accounts at any given time and the credit manager has to make decisions very quickly with credit information that is often not up to date. As a result of the time pressure of his job, he estimates that during the year, he has about 25 accounts that do not pay. Some of these were sent to collection and others, since they are very small, are written off. In terms of the portfolio he is managing, some credit professionals might feel this is a bad rate, while others might feel it’s acceptable. In my view, it needs to be examined a little more carefully before making a decision.
When we talk about an account that has defaulted, in my view it all comes down to materiality. If the payment default is very large relative to the company’s sales or current A/R balance, then we must pause and analyze why this company went south. For instance, if the balance due was $50K against a total current A/R of $500K, then that’s significant. If you think in terms of a 25% gross profit lost on that unpaid $50K, then you will need another $200K ($50K/.25) in sales to make up for the loss.
Conversely, if the total current A/R is $500K against a total of 25 unpaid accounts totaling $3K, that’s less than a 1% bad debt loss. With a gross profit of 25%, you would need $15K in sales to make this up. Not a small amount of money but it’s something that the company could live with.
So, in my view, it’s not necessarily the number of accounts but the size of the account that needs to be emphasized when evaluating your credit granting approval process.
Nancy Seiverd, President
CMI Credit Mediators, Inc.
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