In the Socratic Method understandings are pitted against one another so as to stimulate rational thinking. To open eyes that are blind, to free captives from prison and to release from the dungeon those who sit in darkness Isaiah 42-7″

We all sit in the darkness and we don’t know what we don’t know. In the following essay on the traditional risk mitigation/risk management vs the profit approach to credit and a/r management I am taking the position that whatever we focus on, whatever we give energy to, we create.

Starting Point and Direction

All things that we engage in must have a starting point and a direction, from the most simple to the most complex. From crossing a street to organizing and managing an organization of thousands or a country of millions; there must be a starting point and a direction so as to most effectively get across the street, without being run over in the process. The meaning of words is important for they convey values and with words we paint pictures in the minds of others.

The starting point of this essay is that efficiency is better than inefficiency, but what is the meaning of efficiency? Efficient, the quality of being effective as measured by a comparison of cost vs. return; the greater the return the more efficient the effort. To be efficient is to be powerful in effect with little waste of effort.

Nobel Prize winner, Ronald Coase, wrote that in the physical world there are costs or friction involved in any endeavor. In business there is the original cost or friction of starting a business or of acquiring a business i.e. acquisition costs or friction , the the go-going friction or costs of doing business i.e. transactional costs or friction, and then there is the greatest friction of all..the friction of failure, i.e. something goes wrong somewhere.

In business the cost of failure can be staggering . Some years ago I was speaking to a Vistage group of CEOs in S. Calif.; one of the members of the group managed a chain of white linen tablecloth restaurants and when asked the cost of a customer sending back a meal he responded that it required selling 32 to 33 additional meals to make up for the loss of one meal being refused by a customer. Think about that; 32 to 33 times as much cost and effort to make up for one failure; that’s a lot of waiter runs to the kitchen. Inefficiency is the opposite of efficiency, a lower return for the cost incurred.

Efficiency is the starting point of this essay and the direction is enhanced profitability. This essay is about how the Profit System of B2B Credit and A/R Management is more efficient and therefore more profitable than the old Risk Driven Approach to Credit and A/R Management.

Some facts to keep in mind:

1) 80 to 90% of B2B sales are made based on payment at a later date, i.e. credit is extended
2) A/R , short term money due from customers for the purchase of goods and services is often one of the largest asset a business has…on average a/r represents 40% or more of the total assets
3) Next to cash on hand the A/R is normally the closest thing to money in the bank, it’s a very liquid asset4) That there’s a cost factor of 8 to 14 times as much involved with selling to a new customer than there is in selling to an existing customer..the repeat sale is most often the most profitable sale

Enhanced Profitability
I’ve stated that the direction of this essay is enhanced profitability, but there are different ways for a business to enhance it’s profitability:

1) There’s the Enron Model, i.e. cooking the books which means fraud and crooked if not illegal dealings
2) Increasing sales while controlling the cost of new sales and taking advantage of reduced unit cost per sale
3) Constant Improvement, i.e. meeting or exceeding customers’ expectations at a lower cost.

In this essay I’ll focus on Increasing Sales and on Constant Improvement. The only thing I have to say about cooking the books to enhance profitability is that if you go that route you may find yourself with a room mate named “Loco” who insists you wear a little apron…don’t do it.

Risk or Profit

Much of the traditional Risk Approach to Credit and A/R Management comes from the period following WWII . Credit was at that time defined as the ability to pay, as trust and faith that a debtor would repay. Past due A/R Management was called “collections” and was defined as the enforcement of payment. It was a time of pent up demand and of growing demand for goods and services, it was a time of Americans having money in the bank or in war bonds, it was a time of great social change worldwide and a time of limited competition .

In a seller’s market, of people standing in line with cash in hand and wanting to buy things, credit was seen as a privilege and as a favor to some and not others. In such a business environment the focus was rightly placed on avoiding the risk of customers failing to pay, of incurring bad debt losses. DSO, average turn time on the A/R, and % bad debt were appropriate performance measurements when the goal of risk management rightly contributed to enhanced profitability.

In his book, The Structure of Scientific Revolutions, first published in 1962..Thomas Kuhn defines a paradigm as an accepted set of givens which provide a model problem and a successful solution that works for that time. And as things change the old paradigm becomes incompatible with the new reality. New knowledge in time brings about a shift, a Paradigm Shift.

The shortages of the 50s are long gone. In today’s world of huge international companies and of increasing local small businesses, of big box stores and of cyber competition the old risk management paradigm is a handicap. Today’s world is very different from that of the 1950s and the old risk management/accounting way of thinking of credit and a/r management must give way to a new understanding if modern companies are to utilize credit and a/r management to its fullest profit potential.

In order to compete in today’s world modern companies must have quality in their products and services and quality in the way they carry out business functions. A lack of quality in a business will lead to increased cost of doing business for everyone involved in a transaction and in time will result in the failure of a company to survive, much less turn a profit. The paradigm has shifted.

Organizing and Documenting Knowledge so as to Achieve Efficiency

When I first entered the B2B consulting field in 1982 I’d ask clients for their Policies and Procedures, for their operations manual. Small and large companies alike operate mostly on a word of mouth basis, i.e the new guy learned from the old guy who in turn learned from the dead guy.

Word of mouth operations is like the game children play where they sit in a circle and the first kid whispers something to the kid next to him/her who in turn whispers what they think they heard to the next kid and so on. And in the telling and retelling things change greatly. And while this is a fun game for children, word of mouth operations in a business leads to the friction of failure…to increased inefficiency, increased costs of doing business for seller and customer alike and to decreased profitability for seller and customer alike.

In the course of working with companies of varying size and across industry lines I developed a methodology for organizing and documenting the knowledge needed to achieve efficiency. The 5 Organizational Ps were developed and copyrighted by A/R Management Group, Inc in 1982.

The 5 Organizational Ps Applied to B2B Credit and A/R Management

In order to achieve efficiency , to be powerful in effect with little waste of effort, it is required that three groups within a business be involved in determining and defining The 5 Organizational Ps for every function of that business, including credit and a/r management:

1) Management
2) those who do the work i.e. carry out the process
3) those affected by the process must all contribute to and understand:

The 5 Organizational Ps.

1) Purpose…why incur the costs associated with that function of a business ?
2) Policies…goal driven guidelines for the major components within that function that support the Purpose.
3) Procedures…the steps necessary to achieve the goals for each of the major components.
4) People Requirements…skills, training, education needed to successfully carry out the steps in the Procedures.
5) Process Monitoring and Performance Measurements…the monitoring of the key steps to ensure quality in the Procedures and measuring performance against the goals for each major component.

If the goals are good and achievable but yet not met…then there is a problem either with the Procedures or with the People.

The Purpose of Credit

Why should a for profit business create the additional administrative costs associated with gathering customer information, investigating customers, establishing customer accounts, billing and past due a/r management ? Why should a for profit business incur the cost of carrying A/R, i.e. the time value of money? Why should a business run the risk of customers failing to pay and of suffering bad debt losses?

Over the years I have surveyed thousands of business owners, CEOs, and senior business managers on the above questions. Their answers?

1) Required…customers require that the product/service be provided and that they be given time to ensure that the product/service meets their requirements; they also require time to process the bill for payment.
2) Downline…customers need time to add value to the product/service purchased and to make sales to their own downline customers before they can pay.
3) Competition…credit terms, i.e. payment at a later date, are the norm in an industry and competitors extend credit to customers.

If customers are able and willing to pay at the time of purchase then credit and the costs that go with extending credit should not be extended. If a business is the sole source of what customers want, i.e. there is no competition, credit and the costs that go with credit should not be extended.

If the focus, the goal of a commercial business is on risk management and on avoiding past due credit customers and bad debt write offs; and not on profitability… then credit, and the costs that go with extending credit, should not be incurred.

Credit however is not about trust or faith…these are but factors to be weighed and considered in extending terms and conditions of sale .
Credit is the selling of a product/service based on payment at a later date.
Credit is a lubricant of commerce and allows for the expanded movement of products/services, i.e for enhancing profitability.
Credit is not an accounting function but primarily a sales support function of business.

In today’s world No Credit means No or Very Few Sales and an untapped profit potential.

Credit Policies

Many confuse policies (goal driven guidelines for the major components) with procedures ( steps to achieving goals). There are four majors components to the credit and a/r management function of business:

1) Credit Approval…the goal being to maximize profitable sales while minimizing bad debt
2) Billing…the goal being to facilitate payment
3) Past Due A/R Management (not collections)…the goal being to Complete The Sale , to keep credit customers paying and placing repeat orders while identifying and controlling the small % that represent a potential for loss
4) Internal Communications..the goals being to a. monitor the keys steps in the process measure performance against the goals c. to identify and communicate areas of opportunity for improvement

Credit and A/R Management Procedures

While there are some basic key factors that must be considered and weighted in credit approval:

1) Customer Profile…who the customer is and how they do business
2) Past Performance…the customer’s track record, or lack thereof
3) Product Value at Time Of Sale….margin, demand, business capacity

Every business is unique! The step by step method for achieving the goal of maximizing profitable sales while remaining confident of payment will and must vary from company to company.

In billing we want to follow the TACU method, i.e. billing must be timely, accurate, complete and understandable, but again the steps will vary. Past due A/R Management , the Completion of The Sale (not collections) can best be achieved by using the same four steps found in sales to determine why a customer is past due and to correctly deal with the root cause.

1) Contact
2) Identify type
3) make presentation based on type
4) close and follow-up

People Requirements

Based on the steps involved, i.e. the procedures the people with the right skills, education and abilities must be matched to the each job. All too often due to the misunderstanding of the profit role for credit and a/r management by business owners, CEOs and senior managers… the wrong people are placed in these jobs to the detriment of a business and of it’s customers alike.

Process Monitoring/Performance Measurements

Errors are costly for everyone involved in a business transaction. The key steps in the process must be monitored to ensure quality in how a function of business is carried out.

Some years ago I had an opportunity to work with Dr. Don Rice who then headed up
The Thomas Reed Center at Texas A&M. Dr. Rice taught that “Employees respect (do) what management inspects (measures) and not what management expects.”

One of the first questions I ask potential new clients is, “How do you measure performance for the Credit and A/R management function of your business?” If they answer that they use the traditional DSO and % bad debt measurements I know that they are sending an out of date message to their employees. That they are giving energy to preventing loss and not to maximizing profitability.

I tell clients that if they want great DSO (average turn time on A/R) and low bad debt all they have to do is qualify new credit customers so that only the best are approved and to place all past due customers on credit hold/stop…..but that if they choose to do so they can forget about enhanced profitability.

There are a number feedforward reports and communications that the credit and a/r management function of business can provide so as to achieve new and on-going levels of efficiencies throughout the entire supply chain of suppliers, sellers and customers and thus drive down costs for everyone.

New Performance Measurements to Replace DSO and % Bad Debt

If the goal of credit approval is to maximize profitable sales then a company should track the % of applied for dollars approved, or even exceeded…while remaining confident of payment via terms and conditions of sale. If the goal of Past Due A/R Management is to keep credit customers paying and buying then the % of credit customers in a position to do so should be tracked. With both these performance measurements the Product Value at Time of Sale must also be factored in.

A Profit Philosophy

As with all things human there must be a core philosophy or a belief that defines how we see the world and our place in that world. Pragmatism is an early 20th century American philosophy that states that the meaning or value of an idea lies in observable practical results. Whatever works is likely true and because reality changes “whatever works” will also change. Efficiency is pragmatic and pragmatism requires that one lives in the moment and not in the past.

Credit and A/R Management may be the most misunderstood and underutilized functions of business. It represents a Profit Center begging to happen.

The Author

Abe WalkingBear is an International Speaker / Trainer / Consultant on the subject of cash flow / sales enhancement and business knowledge organization and use. Developer of the copyrighted Profit System of B2B Credit Management, and President of, he is the author of Profit Centered Credit and Collections 1999, co-author of STAFDA’s Foundations of a Business 2007, and co-author of the new international book, The Best Kept Profit Secret: The Executive’s Guide to Transforming a Cost Center 2009.

Bron: A/R Management Group