Clearly, it’s a challenge. You’re faced with a company that most likely is not paying its suppliers within terms. Lack of revenue makes it impossible to cover their accounts payable. Suppliers, therefore, refuse to sell to them. Denied product to sell, they are unable to produce revenue. You get the picture. Chances of such a company breaking out of this downward spiral and turning itself around look pretty slim.

It seems denying open account terms to a company in this situation is a no-brainer. But it’s not always that clear-cut. There are situations when you may want to consider helping the customer out. They may have been a good customer for years and are just recently having difficulties. Perhaps they are a primary customer and losing them could put you in a difficult situation.

Obviously, when you can’t just say “no”, you can’t simply ignore the facts and say “yes” either. So what can you do? Outlined below are five considerations that can help you determine your response.

1. Why is the company in trouble?

There can be any number of reasons why a formerly profitable company becomes unprofitable –insufficient sales, shrinking profit margins, excess costs, even poor credit and collections management. Determining what’s going wrong is important in deciding whether or not to extend credit to such a company. Taking the following steps will help you get to the bottom of things.

Ask them – face-to-face. If possible, perform a site visit. Speak with the owners and managers. Ask them for their "take" on why the company is in difficulty.
Review the financials. If you don’t have current financials from the company, now is the time to require them. Start with the balance sheet. Are they building inventory and not able to sell it? Do they have a negative cash position? Have they maxed out their borrowing base? Is their working capital strong enough to support short-term liabilities even though they are losing money?
Check recent trade payment history. While an analysis of the customer’s financials is important, the financial statement is only a compilation of information and may not fully reflect the actual financial picture of the company. There may be cases where the financial ratios are “text book perfect”, yet trade payments are found to be substantially beyond terms. Examining the promptness of recent trade payments, therefore, may provide a more accurate picture of the financial strength of the business.
Take in the whole picture. It might be helpful to view the firm as if you were considering acquiring the company. In the Turnaround Management Australia blog, Michael Fingland, Managing Director of Vantage Performance, provides a checklist of items to consider as “Warning Signs of a Company in Trouble”. This checklist includes objective considerations (found in the financials and elsewhere) as well as more subjective areas to consider, like the attitude of employees and middle managers.

Once you’ve determined the actual reason for the customer’s difficulties, you can better assess the likelihood of its being able to turn itself around. You might also be able to make some suggestions. For instance, if they’re having difficulties getting payments from their customers, maybe they need a reliable receivable management firm to assist them.

2. What is the company doing to turn itself around?

This is perhaps the most important point to consider because it indicates the company’s commitment to itself, its customers, and its suppliers. You’ll want to perform a site visit or have a personal conversation with management to identify what changes the company is making to improve its situation. If there have been no significant efforts to improve cash flow, profitability, or late payment issues, it’s a pretty good indicator that the company is either incapable of constructively dealing with its problems or is in denial. In either case, it’s not a good risk.

3. How much risk are you able/willing to take?

Consider the following questions:

If you produce the product and this customer defaults on payment, can you sell it elsewhere? Or will you be stuck with specialty/customized products and no market?
If you perform a service, how essential is that service to this customer’s continuing business? Is the service essential to their ability to make sales? The more essential your service is to their business, the more likely they’ll find a way to pay you.

You will need to weigh the difference between loosing the customer by refusing open account terms, against the lost revenues if the customer fails to pay. Also factor in the long-term benefit of customer loyalty, should you opt to support the company through a difficult period.

4. What kind of security is feasible?

Once you’ve made the decision that you want to keep and work with this customer, it’s time to consider potential means of securing the sale. You might ask for a personal guarantee or letter of credit.

If your buyer is located in Mexico (and other Latin American states), then you can request they sign a non-possessory pledge (prenda) or promissory note (pagaré) (see Reducing Risks on Credit Sales into Mexico-Part 1).

If you’re selling products to a U.S. company, then consider perfecting a security interest per UCC (Uniform Commercial Code) Article 9. Many other countries have similar means of securing the creditor’s interest in goods being sold.

Note: When seeking to use security mechanisms, it’s essential that you use the services of a party knowledgeable of the laws and rules pertaining to secured transactions in the debtor’s locale.

5. What kind of “creative” terms can you offer?

There are creative options you can offer customers to help them purchase your product while reducing your risk. Some possibilities:

½ cash in advance; ½ open account. If the customer doesn’t pay within terms, all future sales should be strictly on a cash-in-advance basis.
Shortened credit terms, like Net 15 or Net 10 etc.

It's Your Decision

The decision to continue or discontinue providing credit to a company in trouble isn’t an easy one. Developing a clear understanding of the company’s issues and efforts to turn itself around, as well as your company’s appetite for risk are essential to making that decision.

If you do decide to go ahead and work with the customer through its challenges, you’ll need to be creative in developing an approach that will give this customer what they need in the short-term, while providing an acceptable level of protection for your company in the longer term.

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This information is provided by ABC-Amega Inc. -- providing 1st and 3rd party commercial collection services since 1929, and collecting in more than 200 countries worldwide. For further information, contact info@abc-amega.com.

Bill Scagnelli has been with ABC-Amega for more than 25 years and has previously served as Regional Manager. He holds a BA in Business and English from Benedictine College, and certification in Credit and Financial Analysis (Dun & Bradstreet), and Sales and Management (American Management Association). He has over 20 years of experience in the receivable management industry, which includes a number of years as credit manager for Uniroyal.