CEO's, business owners and senior managers need a better way to monitor their company's credit and A/R vital signs. I recently had lunch with Scott Stratman VP of Business Development with Tech Systems. Besides being a good and old friend whose company I always enjoy , Scott Stratman is intelligent, yet practical and down to earth and he asks some great questions…he makes me think. Scott's first question was, "What vital signs regarding credit and A/R should managers be monitoring?"
The top guys in companies need reliable information on which to develop strategies and then monitor the execution of plans. Management team members need to establish clear goals for the different functions of the organization and then be able to quickly check the progress or lack of progress being made toward those goals.

They need to hire the right people capable of carrying out the tasks and then measure their work. And lastly but maybe most important, the management team must constantly work on everyone knowing the direction the company wishes to take and then working together to get to where the company wants to go.

My answer to Scott's question was, " Before you can monitor vitals for credit and A/R you have to know what you are dealing with and what you want. Many managers misunderstand and underutilize their credit and A/R function. Keep in mind some basics:

1) 80 to 90 % or more of all B2B sales involve payment at a later date…credit terms are extended

2) A/R, short term money due from the sale of products or services is often one of the largest assets a company has. On average the A/R is 40% or more of the total assets.

3) Next to cash on hand the A/R is the most liquid asset being but one step removed from money in the bank.

4) In the course of approving credit sales and then managing the A/R, the credit and A/R function interfaces with customers, sales, marketing, accounting, operations, the warehouse, service, vendors/suppliers, attorneys, transportation and many others involved with the supply chain."

Credit Sales
Companies make an investment in getting business customers to the point where they want to buy. A good thing to know (vital sign) is the number of new customer information forms (not credit apps) being submitted by sales to credit. If the number of submitted new customer information forms is down during key times of the month compared to the prior month and the same month the prior year, sales people can be incentivised to turn the month around. This can be done by daily contests that include the credit area timely processing of submitted new customer information forms.

Another good thing to know (vital sign) during key times of the month is the total amount of credit that has been applied for and what % of that applied for credit was approved by the credit guys. A good credit manager can be worth 3 to 4 good sales people… if they view pending sales as their highest priority and focus on finding ways to approve profitable sales while remaining confident of payment.

When sales people focus on quality customers and credit people focus on both making the deal happen and on granting a larger line than was requested, the % approved should be more than 100% of the applied for amount.

If during key times of the month the % of applied for credit approved drops, is it because the quality of the customers is down, is it due to the economy or due to the sales force calling on the wrong market? Or is it because the credit guy isn't working hard enough to find ways to make profitable sales happen?

What is watched gets done.

Sometimes management sends confusing messages to the credit guys, they'll stress the need to get pending and profitable sales on the books and then measure the credit area's performance based on DSO and % bad debt which in turn leads to the credit area focusing on risk rather than focusing on sales and profit.

Sometimes management itself doesn't understand or know the proper profit approach to credit approval and therefore can't provide the credit area with the necessary understanding and training on how to weigh the customers' profile and past performance with the company's product value at time of sale …so as to maximize sales and minimize risks.

A/R Management
The proper management of A/R (accounts receivable) results in good cash flow, sustained repeat sales and controlled bad debt. The vital sign that is directly connected to cash flow, repeat sales and bad debt is the PDI (payment days index) at the end of the month and the daily collection % during the month.

PDI = Terms of Sale (for each term of sale) / Payment Percentage (end of month)

Start with the beginning total AR balance as of the first of the month. This means all A/Rs regardless of age. Any new credit sales made during the month will be picked up in the next month's beginning total A/R balance. For example let's say that our total A/R balance as of the 1st of the month is $1000. Track payments and credits on those invoices that make up the beginning total A/R balance.

During key times of the month (the 10th and the 20th) we want to compute the Payment Percentage as of that date by dividing the amount paid by that date by the beginning total A/R balance. If, by the 10th we have been paid $200 of the beginning $1000 total balance, our payment percentage as of the 10th is 20%. We can compare this month's 10th day payment percentage against last month's 10th day payment percentage.

If last months 10th day payment percentage was 40% and this month it's 20%, it doesn't mean that we are doing a poorer job this month than last. If there's a great variation it's not a matter of good or bad, but of why? And that's the question management should be asking.

A lower payment percentage may be due to the A/R person going on vacation and no one following up on past due A/R. It may be a matter of a product / service with a lower Product Value being sold to someone with less that perfect past performance (pay record). Or it could be due to the accounts being worked in alphabetical order rather than by largest dollar first.

If by the 20th, we've been paid $400 of our beginning balance of $1000 our payment percentage as of the 20th is 40%. By tracking the payment percentage during the month we can determine if we need to exert greater efforts. If we are not happy with the payment percentage as of the 20th, we have 10 days in which to turn things around. 

At the end of the month compute the PDI by dividing the payment percentage into the terms of sale. For example: at the end of the month, we have been paid $500 of our beginning A/R total of $1000, our payment percentage is 50% or a 0.5. If we are selling on 30 day terms our CDI would be 60 days .

PDI = Terms of Sale (for each term of sale) / Payment Percentage (end of month)

If you have varying terms of sale, you must compute the PDI for each and then average them out, just as you would do with DSO. If you have a good payment percentage your cash flow will also be good and more of your established credit customers will buy from you. Keep them paying and keep them buying.

Also a good payment % will contribute to controlled bad debt because it's a positive indicator that the accounts are being worked and that potential bad debt is identified earlier in the process when the amount due is less.

"What's a good PDI?," asked Scott Stratman
All vital signs will vary based on the variables involved. For example if a company's product value at time of sale is low due to sales and related business activity being down 20% , the unused capacity to do business (fixed expenses) goes up and when this is factored in to the credit approval decision making, riskier credit sales should be approved even if this results in slower payments, a lower paymnet % and in time to an increase in bad debt. If done right the utilization of the unused capacity (fixed expenses) will more than off-set the slow payments and increased bad debt. The purpose of vital signs is to draw the focus of management. Again the question to be asked when it comes to vital signs is "Why?.

I'm not a mechanical sort but I've
learned the hard and expensive way that when the oil or service engine idiot light comes on it means that you're an idiot if you don't pay attention to it. In the course of approving credit sales (80 to 90% or more of all sales) and then managing the resulting A/R, the credit area interfaces with many of the different facets of the supply chain and can identify areas of opportunity for improvement .

Dr. Demming said that the true cost of errors is unknown and unknowable. Dr. Coase said that of all the frictions (cost) involved with business the greatest friction of all is the friction of failure. A vital sign that should be monitored and given management attention and energy is the number of "systems problems" (something went wrong somewhere) and the dollars therein involved. Systems problem are friction and drive up everyone's cost of doing business …seller and buyer alike. The smart guys pay the tuition for their education but once. The not so smart guys buy new engines.

That Scott Stratman is a smart man who asks good questions and makes me think and that's but one of the reasons he's my friend and why I let him buy lunch…thanks Scott.

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.