Credit Management: How Did Your Books Look Last Year? This Year?

We’ve now turned the page into the year 2013. How well did your company’s credit management plans mitigate your risk and allow you to take on the necessary about of business?

Just one year ago many sat at their desks to review the prior year’s financial successes and failures, lamenting at any lost money and celebrating any small steps towards higher margins. The same event is happening around the country this morning, as we look back at the 2012 calendar year and think about how to make our businesses better in the coming year.

Why Good Credit Management Is Essential In The Construction Industry

Credit Management: How Did Your Books Look Last Year? This Year?

Debt Ratios in the Construction Industry. Material Supplier has a 48% Debt Ratio, Homebuilders over 50%. Data from Aswath Damodaran, NYU Stern, 2012.

One of our nation’s oldest and largest industries – the construction industry – is particularly vulnerable to poor credit planning.

The chart on the left shows some debt-ratios separated by industry. Building material supply companies are running with a 48%+ debt ratio at any given time, which means nearly half of the company’s assets are provided via debt.

The trend of high debt continues across different segments of the construction industry. Homebuilders, for example, have a 50.7% debt ratio.  Compare this to other industries (like the restaurant, apparel or e-commerce industries), and you can see that debt is a much bigger challenge for those in construction.

We addressed the debt ratio issue and how to control the excessive risk in a post from last year:  High Debt Ratios In Building Supply Industry Means High Risk – Can You Control The Risk?

What does this debt ratio issue mean in a nutshell?  It means that material suppliers are always owed a lot of money.  And who owes suppliers this money?  Construction companies.

Credit Management: How Did Your Books Look Last Year? This Year?

Failure rates of businesses after a 5 year period by industry sector, showing that after 5 years only 36.4% of construction businesses survive. Data compiled from the Census Bureau’s Business Dynamics Statistics by Scott Shane for Small Business Trends.

Unfortunately for the industry, construction companies fail more often than any other type of business in the United States.  Take a look at the chart to the left here.  As you can see, only 36.4% of construction businesses stay in business after a 5 year period. This exceeds every other industry sector.We spoke about this issue in another post from last year: Mechanics Lien Importance Highlighted By Contractor Failure Rates.

This is a recipe for disaster.

Building material suppliers extend credit more often than most other industries, and they are extending credit to companies that fail more often than most other industries. Managing and mitigating this credit risk is critically important.

What Bad Credit Decisions Mean To Your Business

How toxic is a bad credit decision to your business?  I’m glad you asked.

In more bad news for the material supply and construction industry, it seems that these firms have extraordinarily slim profit margins.

Credit Management: How Did Your Books Look Last Year? This Year?

The cost of bad debt in the construction industry. Since building material supply companies have an average 1.25% net profit margin, a tiny amount of bad debt ($12,500) sets the company far back in needed revenue to make up for the loss ($1m). Data from Bloomberg Businessweek Magazine.

Bloomberg Businessweek Magazine pegged the net profit margin for the Building Material and Supplies Dealers industry at just 1.25%.  This is incredibly slim.  The chart on the left here illustrates just how slim these margins are.  If you think about it terms of real money, if a building material supplier writes off just $12,500 in bad debt for the 2012 calendar year, that means they will need $1,000,000 in revenue to make up for the loss.

In other words, if you’ve written off $12,500 from 2012, you may need $1,000,000 in revenue before you break even.

These numbers may help you realize that credit decisions, credit management and credit policies present a huge challenge. A single bad credit decision can easily amass an uncollectable account of $12,500. With such low margins, it’s almost impossible to make up the loss.  What can you do?

How To Implement An Immaculate Credit Policy And Make More Money

Now you understand that the construction industry is vulnerable to debt and bad credit decisions. What now? How do you solve that problem and continue to do business without bleeding money?  How do you stop the losses and actually increase the profit margin without the simple “more revenue” solution?

The solution is buried in assembling great credit tools and great credit policies for your company.  The solution is in credit management.

1. Review (or Create) Your Credit Policy.

The start of the new year is a great time for you to sit down and review (or create) your company’s credit policy. Your credit policy should take the following into account:

  • Concrete methods to separate those who can and cannot get credit
  • Concrete factors to guide the credit manager in determining who must give additional security (personal guaranty, joint checks, etc.)
  • When and how lien rights will be used to secure accounts (see: Lien Policy)
  • How long are your credit terms?
  • What is done when a payment is not made?
  • What is done when an account goes into default?

2. Incorporate Lien and Bond Claim Protections Into Your Credit Plans.

[pullquote style="right" quote="dark"]The lien and bond claim laws exist all around the country for the precise reason of helping a high risk industry (construction) deal with credit problems.  If you’re not utilizing these laws you are simply ignoring the one thing out there to help your company deal with its credit challenges.[/pullquote] If you are not using the mechanics lien and bond claim laws to protect your accounts, you’re making a very very bad decision for your company.  There are no and’s, if’s or but’s about this one.

The lien and bond claim laws exist all around the country for the precise reason of helping a high risk industry (construction) deal with credit problems.  If you’re not utilizing these laws you are simply ignoring the one thing out there to help your company deal with its credit challenges.

3. Stick To Your Guns

All the planning and policy writing in the world is useless if you don’t execute.  I can’t count how many supply companies I’ve consulted with over the years who have fantastic credit policies and procedures but simply don’t execute them.  They make too many exceptions, they get lazy about lien compliance, etc. etc.

Commit yourself in 2013 to not only having a great credit and collections policy, but also to execute it.

Credit Management: How Did Your Books Look Last Year? This Year?

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