Question: What do credit and collections mean for small businesses?

Answer: (from Paul Legrady, director at ARM advisory firm Kaulkin Ginsberg)

insideARM primarily discusses the collection of charged-off consumer debt – the unpaid credit card bills, phone bills, and other receivables that companies have made to individuals.  Most of these lenders – the credit card companies, telecommunications companies, utility companies, etc. – are large corporations.

An important part of the collection industry involves a totally different type of collections – the unpaid invoices owed to one small business by another.  It’s interesting that almost all of the businesses that operate in the U.S. -- 99.9 percent -- are small businesses, defined as having fewer than 500 employees.  It’s also true that about half of the small businesses shut their doors within their first five years of operation.

Like credit card companies have customers who can not (or choose not to) pay bills, small businesses also have outstanding receivables, the unpaid invoices that pile up over time and drain the financial strength of companies that make sales based on credit.  The inability small businesses to make good decisions about who should receive credit, and how extended credit should be collected, contributes without question to the 50 percent failure rate described above.

The credit risk managers that work within these companies have real challenges as they decide how credit should be extended and how overdue bills should be collected. 

• They must screen potential clients as they are being approved for purchases.  In this way, the salespeople working for a small business, whose job it is to close a sale, may conflict with the risk managers within those companies, whose job it is to approve only desirable sales.  When a salesperson says “yes,” a credit risk manager might say “no” – a challenge at a time when most small businesses are looking for more on the top line.

• They must be technically precise, ensuring that invoices, purchase orders, and other documentation involved with a sale to other businesses  are completely accurate.  Invoices can get lost or misunderstood by clients in the short term.  In the long term, collection efforts rely on the technical accuracy of these materials, especially when disputes are resolved through legal channels.

• They rely on information suppliers.  As companies that grant credit to consumers run credit scores for individual borrowers, commercial lenders access sources about small businesses that describe the financial health of their potential and existing clients. This information is crucial to the credit granting process, as well as the collection process that follows.

• They draw on the resources of service providers that specialize in collections.  The Commercial Law League of America, for example, has more than 3,000 attorneys and commercial collection agency managers that specialize in specific types of commercial collections, many times in specific industry sectors (e.g., shipping) and geographic areas (e.g., Florida).

For small businesses like consumer credit grantors, the decision of how to extend credit goes a long way in determining how successfully that credit will be collected after invoices go unpaid.  Making these decisions more effectively can contribute to the overall financial strength of small businesses in this challenging economy.