Contracts and who can sign them

Can anyone sign a contract? Most people agree the answer to this question is No. For example, most people acknowledge that a Minor [someone under 18] cannot sign a valid, enforceable contract. So… who can sign a valid, enforceable contract on behalf of a customer? More specifically, who can sign a valid credit application on behalf of a business?

There are several requirements for creating a valid legal contract. One of the most important to credit professionals involves the idea of contractual authority. To be enforceable, the person signing the credit application must have authority to do so. What constitutes authority to do so? This question can be answered this way: Credit professionals often need to rely on the concept of ‘apparent authority.’ Why? Because creditors don’t know who has actual authority to sign the credit application on behalf of the applicant.

The intent of the legal concept of apparent authority is to protect third parties [such as creditors] who might otherwise incur losses if the signature received did not bind the debtor company. Basically, apparent authority means this: If a reasonable person [such as a creditor] believes the person signing the contract has the authority to do so, that signature is binding on the applicant company.

So, what do I look for? I look for the title of the person signing the application. I expect to see that an Officer or a business owner has signed the credit agreement. Do you agree? Do you disagree? I think this is worth discussing this with your attorney.

The Role of the Credit and Collections Dept.

The Role of the Credit and Collections Department

The credit and collection function is an important component of any company's business operations.  Using creative methods whenever necessary to structure transactions so that sales can be approved, the credit department can make a significant contribution to sales and profit maximization. The key is knowing when and how to accomplish the sale safely. The key is to find the best way to minimize the risk of late payment or non-payment by customers. The core activities of the credit department include:

·       Maximizing sales,

·       Accelerating cash inflow,

·       Minimizing bad debt losses,

·       Reviewing and approving new accounts,

·       Developing and updating credit and collection policies,

·       Establishing appropriate credit limits and terms of sale for new and active customers,

·       Creating new or more appropriate payment terms [terms of sale],

·       Placing accounts on credit hold, and releasing orders from credit hold,

·       Managing the collection function,

·       Maintaining current information in the credit file on each active customer,

·       Documenting credit decisions and actions,

·       Performing financial analysis on customer financial statements,

·       Researching and resolving disputes and deductions that would otherwise delay or prevent payment of accounts receivable,

·       Communicating with other departments within the company including order entry, sales and shipping,

·       Management reporting, and

·       Safeguarding the company's investment in accounts receivable.

Collections and Credit Holds:  Customers occasionally overreact to a decision by a creditor company to place orders on credit hold.  However, most debtors understand the collection process that creditors use, and understand the risk they face when they delay payment.  Occasionally, the penalty for delaying payments to creditors involves a credit hold.

Collections and Credit Risk Management: Most collection problems and bad debts result from a flawed or inadequate initial credit investigation. It may be helpful to think of credit extension as making a loan to an applicant.  We know that a bank would not make a loan without a completed and signed application, and without a detailed understanding of the creditworthiness and financial worth of the applicant.  The care that banks take in approving loans should not be lost on trade creditors.  A creditor should not approve open account terms until there is sufficient documentation to show the applicant is creditworthy

Carrying Costs of your Accounts Receivable

Determining the Carrying Costs of Accounts Receivable

There are five major costs associated with accounts receivable.  They are: bad debts, interest cost, opportunity costs, administrative costs, and miscellaneous costs.  Each cost category is described below:

Bad Debts:

Every sale on open account terms carries a risk of nonpayment.  Nonpayment may be the result of a legitimate dispute.  Nonpayment of larger dollar amounts is often the result of a customer filing for bankruptcy protection.

Interest:

What does it cost to carry past-due accounts?  If a 5% net profit is realized on sales, for every $100 accepted in credit, $95 is paid for product, expenses, taxes, and so on.  Interest alone can erase the $5 profit in a short period of time:

Interest Costs at 12% Per Year:
First month: 12% x $100 = $12.00 (divided by 12 months = $1.00)

Opportunity Costs (e.g., Alternate Use of Capital):

Consider an example using a yearly sales figure of $12,000,000 meaning $33,000 per day. If the accounts receivable investment improved and the number of DSO decreased, the following amounts could be released or added to cash flow: by three days - $100,000; by six days - $200,000; by thirty days - $1,000,000. The funds could be used for a variety of things including expansion or new product development, or internal improvements such as salary and overhead increases.

Miscellaneous Costs: 

Losing the ability to discount (a crucial cost, especially in a high-interest period); paying penalty/late charges (in addition to the possibility of restricted credit); increased risk factors (the older the debt, the harder to collect); maintaining administrative, bookkeeping functions; letters of credit fees.

Administrative Costs:

Administrative costs would include the cost of operating a credit and collection function.  It would include the salaries of the employees of the credit department along with all of the ancillary costs of managing the credit function such as the annual cost of credit reports.

Credit-Decision Making

The credit department must make difficult decisions and take actions to implement those decisions every day.  Some people enjoy being involved in the credit decision-making process.  Some do not, often because in the credit field there are almost no absolutes.  There are no absolutely correct or totally incorrect credit decisions.  Some people acknowledge the uncertainty and welcome the challenge, and others do not.  A small number of individuals delegated the task of making credit decisions effectively freeze up and are incapable of making important decisions involving significant amounts of money in the form of offering credit terms exactly because the information available is insufficient to determine with sufficient certainty that the would-be customer has the ability and willingness to pay their debts to the creditor as they come due.

There are a number of factors that influence the credit decisions being made. In each company, the relative importance of each of these factors is different. What remains constant is the fact that credit managers do not operate in a vacuum unaffected by the goals, the problems, and the challenges facing the companies they work for. Credit managers that fail to appreciate the needs of their employer will be seen as lacking in business acumen at best, and as expendable at worst. Some of the more important factors affecting credit decisions include:

1. Competition. Competition will affect your decisions relating to establishing a more lenient or a more rigid credit policy. The stiffer the competition, the more likely the credit policy will be more lenient. In a buyer's market in which supply exceeds demand and the quality of goods offered by various suppliers is comparable, credit policies tend to become more liberal over time.

2. Terms offered by competitors. Generally speaking, the longer the terms competitors offer, the longer the dating your company must offer in order for its products to remain competitive.

3. The laws of supply and demand. When demand for your company's goods and services exceeds supply, the credit manager can have a more conservative philosophy than when supply exceeds demand.

4. General business conditions. In a recession, business may be exceptionally slow. A liberal credit granting policy combined with relaxed collection efforts may be a way to increase sales revenues.

5. Changes in demand for your company's products. When demand for your goods and services is in decline, additional pressure will be brought to bear to liberalize credit granting to retain existing customers and to attract new customers.

6. The amount of bad debt losses experienced. If bad debt losses are higher than expected, senior management may insist on a more restrictive credit policy

7. Inventory levels. High levels of inventory tend to result in pressure to offer marginal customer larger open account terms. The same is true if inventory is seasonal, subject to spoilage, or is custom designed.

8. Profit margins. In theory, the higher the profit margin, the more credit risk companies are willing to take.

9. Market share goals and strategies. If your employer wants to increase market share, chances are good that credit terms will be one element of the negotiation process.

10. The experience of the credit department staff. The more experienced and educated the credit manager and his or her subordinates are, the more sophisticated the credit risk mitigation and management process tends to be.

A note of caution.  Any time a creditor company makes a decision to become more lenient [meaning less risk averse] in response to any of the ten factors described above, they must appreciate the fact that when [not if] business conditions change and the creditor company decides it wants to be more risk averse, that creditor company is likely to experience a significant amount of push-back from customers accustomed to the less risk averse way of managing the open account credit relationship with customers.  For example, if a customer is offered an increase from 30 to 45 day payment terms in order to stimulate sales, it will be difficult to convince that customer to start paying invoices in 30 days again

How to Collect on a Bounced Check

Over one million checks written in the United States each year are returned to the depositor.  The most common reason for returned [bounced] checks is insufficient funds.  Normally only individuals or companies that regularly and deliberately write NSF checks for relatively large amounts are actively pursued by law enforcement.  Often, bounced checks from your customers result from poor record-keeping meaning that they are not a deliberate attempt to defraud you and other creditors. When an established customer of yours bounces a check, the credit department should:

·       Contact the debtor immediately by phone;

·       Express concern;

·       Demand an immediate replacement for the bounced check;

·       Insist that payment be issued in the form of a wire transfer or possibly a cashier's check.  If you accept a cashier's check, arrange for that check to be picked up and deposited as quickly as possible;

·       Give serious consideration to placing the account on credit hold and if applicable to your business on production hold;

·       Consider recalling any shipments in transit to the customer.

Some additional considerations:

·       If the debtor is unwilling to replace the dishonored check, notify your attorney or law enforcement;

·       If a check is returned because the account is closed, you should be even more concerned than if a check bounces due to non-sufficient funds;

·       Call immediately and demand an explanation from the customer as well as an immediate replacement of the dishonored check;

·       If you receive what turns out to be a counterfeit cashier's check or money order, contact law enforcement immediately.

The sooner and more forcefully that you as a creditor address bounced and returned checks, the more likely your company will get paid. Under no circumstances should the bounced check be returned to the customer until a replacement payment has been received and has cleared their bank. Why?  Because an NSF check is evidence of the fact that a debt was owed, and the fact that the check did not clear may be evidence of the debtor company's intent to defraud your company and other creditors.

At one time, a Cashiers' Check was the preferred method of receiving payment because these checks were were thought to be a guarantee of payment.  That is no longer true.  In fact, there is a growing trend in the United States involving the use of fraudulent Cashiers' Checks.   Using a laptop computer, any decent color printer and good quality paper, it is easy to generate a fraudulent Cashiers' Check that would fool almost anyone not working inside the bank on which the check is drawn.  For credit professionals, the solution is to request a wire transfer payment rather than a Cashiers' Check.  It should not be a tough sell.  For a customer to get a Cashiers' Check requires a trip to their bank.  A wire transfer can often be arranged by your customer on the phone or using their computer.  The advantages of a wire transfer include:

·       The fact that the creditor is paid more quickly meaning the product can be shipped more quickly; and

·       Wire transfers confirmed by the creditor's bank are not going to bounce and are extremely unlikely to turn out fraudulent.

COD Terms: Slow Pay = High Risk

COD Terms; Slow Pay; High Risk;

If an applicant has a history of slow pay with trade creditors, there is no reason to expect that they will pay your company any better.  For this reason, COD terms may be your best option.  Even COD (cash on delivery) accounts should be assigned credit limits commensurate with the risk that the customer's check might bounce.  Generally, creditors require customers purchasing on COD terms to issue payment in cash or via cashier's check.

Credit professionals need to qualify COD customers for specific COD credit limits. How? One source is credit reports. Review credit reports to see if other creditors are paid as agreed, or alternatively may have placed the account for collection or filed suit over one or more NSF checks. A prudent trade creditor will also request a bank reference and contact the bank before making a decision about offering COD terms. 

Creditors that do not take the time to qualify companies for COD terms will have more NSF checks returned and [unfortunately] more bad-debt losses than companies that establish dollar limits on all customers including COD customers, and assign credit limits accordingly.  Typical reasons for a check to be dishonored by the bank on which the check is drawn include:

·       Insufficient funds; 

·       Instructions to return to maker;

·       The customer signature is missing or incomplete;

·       Payment was stopped on the payment;

·       The account was closed;

·       The check was post dated;

Selling on COD cash terms can result in bad-debt losses. Most common carriers do not allow their drivers to accept cash payments. Therefore, by common usage COD cash terms actually means that payment is due on delivery in the form of a cashier's check or money order made payable to the seller. If the delivery driver makes a good faith effort to determine that the payment received is in fact a cashier's check or a money order, the carrier would not be liable if it turns out that the check or money order were counterfeit. 

Thanks to the proliferation of color printers, scanners, and desktop publishing software, it is easy to make a good facsimile of a cashiers' check or money order. Since it normally takes several days for the check to be delivered to the seller, in many cases by the time the check has been presented for payment and the counterfeit payment is discovered, the criminal and the merchandise are both long gone.   If a COD shipment is refused by the buyer, the creditor will have to pay freight costs in both directions.  If the product is a special order, there may be no ready made market for the goods once they have been returned. 

One solution to this problem is to require a new or unknown customer "willing" to pay for an order with a cashiers' check or a money order to wire transfer you the payment instead.  Simply because a customer has enough money on deposit on a certain day to cover a check it has written does not mean that the money will be available when the check is presented for payment. By hand delivering the check for the first order to our salesperson late in the day, this customer was guaranteed at least one extra day of float on the check before it could be presented to its bank and ultimately returned due to insufficient funds

The Carrying Cost of Accounts Receiveable

There are five major costs associated with accounts receivable.  They are: bad debts, interest cost, opportunity costs, administrative costs, and miscellaneous costs.  Each cost category is described below:

Bad Debts:
Every sale on open account terms carries with it a risk of non-payment.  Non- payment may be the result of a legitimate dispute.  Non payment of larger amounts is often the result of a customer filing for bankruptcy protection.

Interest:
What does it cost to carry past-due accounts?  If a 5% net profit is realized on sales, for every $100 accepted in credit, $95 is paid for product, expenses, taxes, and so on.  Interest alone can erase the $5 profit in a short period of time:

Interest Costs at 12% Per Year:
First month: 12% x $100 = $12.00 (divided by 12 months = $1.00)

Opportunity Costs (e.g., Alternate Use of Capital):
Consider an example using a yearly sales figure of $12,000,000 or $33,000 per day. If the accounts receivable investment improved and the number of DSO decreased, the following amounts could be released or added to cash flow: by three days - $100,000; by six days - $200,000; by thirty days - $1,000,000. The funds could be used for keeping up with competition (for example, expansion or new product development) or internal improvements (such as salary and overhead increases).

Miscellaneous Costs: 
Losing the ability to discount (a crucial cost, especially in a high-interest period); paying penalty/late charges (in addition to the possibility of restricted credit); increased risk factors (the older the debt, the harder to collect); maintaining administrative, bookkeeping functions; letters of credit fees.

Setting Credit Limits

Doing a credit scoring model is a useful way to set credit limits. If you do not have a software program that automatically can assist you with setting limits, you can designate a certain amount of points for each category.

But before you do that, you want to make sure that you have everything in order. This includes:

1. Signed credit application
2. Signed terms and conditions page
3. Signed personal guaranty
4. At least three trade references

And then start calculating. 

For example:

Years in Business:

• Less than five years: 2 pts.
• Over five years: 5 pts.

Payment History:

• Prompt Pay: up to 5 pts.
• Slow 1-30 days: up to 4 pts.
• Slow 31-60 days: up to 2 pts.
• Slow over 60 days: 0 pts.

Personal Guarantee: 5 pts

Once you've got a total score, create a model like the one below and set your client's credit limits accordingly.

12-15 pts.: $10,000-$15,000

8-11 pts.: $5,000-$10,000

4-7 pts.: $1,000-$4,000

<2pts.: Credit Card Only

Hello!

First let me introduce myself, my name is Sandra Rivera and I am the founder of Fidelity Credit Consulting Services.

We are an outsourcing service that specializes in credit, collections and accounts receivables.  We assist small to medium size companies assess risk. One of the main questions I get is, why should I outsource? Outsourcing can benefit you and your company because it allows you to focus on the core aspects of your business. Outsourcing can also be cost efficient since internal costs such workmen’s compensation, health insurance, and other benefits are eliminated.

I plan to use this space as a forum where I can give business owners and others tools and tips related to your accounts receivables and credit, focusing on processes and procedures. Occasionally I’ll broaden the scope of our conversation and look at bigger economic trends (with a focus on receivables and credit of course). This blog will be updated on a weekly basis, unless I feel that there is urgent information I need to post. 

Please leave your comments and questions. They will help the blog focus on the issues that are most important to you!

I’ll start with a few simple tips on credit applications.

1.     Make sure you ask for social security numbers.  This comes in handy if it is a new business and you must run a check on his personal credit.

2.     Ask for at least three trade references and if you belong to an industry credit group even better. They will only usually give you the references they are paying.  If you belong to a credit group you will have access to everyone they are buying from.

3.   When having them sign a personal guarantee, also get a spouse’s signature.  Many times assets are hidden under a spouse’s name