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By | Eddie Pacey 16th November 2012 09:40

Credit insurance: The hidden data-driven force which killed Comet

Money in other people's wallets can be a big asset

A quick look at what happened to high street electronics retailer Comet when its credit insurers slammed their wallets shut should be enough to get any IT business interested in cash-flow, insurance and credit lines.

But while credit and cash-flow are often seen as stale subjects, they can be the lifeblood of business - almost as important as the products and services themselves.

It's not just offering too little credit that destroys a business - too much can do just as much damage. Some 95 per cent of business-to-business deals are transacted on "open credit" terms. This means the products or services are supplied on the premise that payment will be made at a future date - basically getting goods on tick.

Open credit fuels the IT industry, not just simply in the provision of much-needed channel finance, but also in oiling the wheels of business, allowing for growth and increased market reach.

Provision of a credit "line", as opposed to the more commonly referred to "limit" is always generally subject to status checks or pre-determined scorecards.

It is then continuously reviewed and monitored during a business trading cycle to ensure the level set meets the requirement of risk appetite measured against growth. A business is therefore unlikely to have a credit line for life or one that remains at a constant level (or it shouldn’t, anyway).

A credit line is flexible and will move up or down based on reviews and trading history. A credit limit, on the other hand, is obviously a rigid fixed value.

There's gold in them thar credit databases

When you sell your goods on credit to customers, agreeing to receive payment in future, they become "trade receivables" or "trade debtors". These "trade debtors" are actually a substantial liquid current asset that frequently accounts for more than 60 per cent of a company’s total assets.

What many businesses overlook, though, is that a byproduct of giving out credit is the way it creates an invaluable, frequently underused resource: a massive database of clients - past and present - with incredible volumes of data attached to each client. A criticism I often levy is that business leaders rarely use these two significant assets (despite zealously guarding them) to the extent they should - and all too often know very little about them.

Managing, controlling and securing these assets is crucial and yet too many do not afford the area the degree of importance it deserves. The credit department too often languishes in the bowels of finance, incorrectly viewed as a back office function ... while many on the sales floor like to call it the "sales prevention" unit. But used correctly, credit provision is a proven profit centre and business driver.

The channel has experienced highs and lows in terms of credit - from the boom times of the early noughties to the low of the past few years, when the "credit crunch" and the lack of credit insurance cover put some pressure on availability - but even then, it was mostly at the top end of the scale. Mid-market clients were left relatively unscathed because of the varying types of credit insurance held by suppliers.

A number of major distributors - such as Ingram Micro, Westcoast and Tech Data - market similar initiatives to accelerate a credit line, generally to small businesses. These are designed to offer an increased credit line to match growth and satisfactory payment (often by direct debit) and are marketed as special offers or “credit limit accelerators”. Offered at lower levels and capped, they do offer some assistance for SME resellers.

But in truth, these simply replicate a standard credit process for review in the general course of business trade, which is always closely linked with other risk factors.

Consider the risks

One concern about distributor accelerator plans is that they insist that a specified percentage of the increased limit be used each month in order to remain part of the programme. This has the effect of forcing the reseller to place more and more of their purchase requirements through the plan provider - a route perhaps to increase a distributor's market share of what is termed “total available market” (TAM). This is loosely worked on judging how much product a client buys annually, its constitution and how much share a supplier holds or can strive for. This is common practice in many business and industry sectors and yet it is so often flawed from a commitment and risk perspective.

There is no guarantee, of course, that having built your credit line from £5K to £200K it will remain unchanged should you not pay on time, file negative financial results or provide interim management accounts that suggest the risk is too high to justify the £200K line.

Give a business too much credit too quickly and there is a risk you may force it into difficulty. It’s a bit like giving an 18-year-old a credit card with a limit of 2K guaranteeing increases subject to percentage use and payment on time. While they might abide by the rule for a few months, there will come a point where they cannot pay a debt that may now have risen to 10K.

Go on, take the credit... or should you?

In recent months, there has been much surprise expressed over resellers declining to take advantage of the now increased amount of credit offered by distribution.

Computer 2000 for example, says only £350m to £400m out of £1bn worth of available channel credit was used by resellers.

The business therefore had existing credit lines to clients totalling well in excess of the sum owed by those clients. This is a common feature in distribution where clients are in their thousands.

Experience tells me management and constant review of your client base allows you to manage the level of credit you provide to match the level of growth you are achieving or hope to achieve.

If one has several thousand accounts with credit lines that do not trade or do not fully use the level of credit provided, then this suggests poor management of credit, diminishing or static sales or a lack of database research by credit/sales/marketing.

Credit lines of £1bn on average credit terms of even 60 days offer annual sales scope of £6bn - clearly well in excess of anything recorded and more than the combined sales of seven of the top UK distributors on the basis of last filed accounts at Companies House (£4.9bn).

The total amount owed by resellers across these seven was in the region of £670m. Excess or unused credit does not therefore necessarily signify a level of growth potential.

Credit availability and use changes; account managers and buyers move on, vendor profiles change, relationships break down, online accounts are granted credit and not progressed and resellers (not unsurprisingly) modify their business practice and offerings continuously without being followed. A growing number that were predominantly hardware/software resellers have placed greater emphasis on managed services, negating the need for historically high credit lines.

Credit is a selling process too

Correctly managed, a database can resurrect sales, create new sales, increase margin and far more importantly, strengthen the client relationship - which then leads to repeat business. This is crucial and yet so often neglected. With correct training and skills, credit management is perfectly placed to deliver as a business development tool with sales and marketing - and yet sadly this opportunity is missed.

Credit is a selling process, very much part of the initial and ongoing client review through to payment and closure of the sale. It must be instrumental in helping to shape direction, repeat business and growth and not be seen as merely a risk or debt collection function. Astute and forward-thinking companies are those that see clients as clients all the way through a business life cycle and not simply as debtors once an invoice is cut.

If you offer credit lines that are unused or under-used, you need identify the reason, work on them and where there is no opportunity, remove them or reduce them. It’s pointless offering a client a £100,000 credit line when the most they will or can now spend with you is £5,000.

If you have too much unused, you’re not managing it correctly or not selling enough. If you have too little to offer or only offer what you have credit insured, you’re being restrictive.

An ideal benchmark for distribution should be a debt-to-active-account credit line ratio of between 65 to 70 per cent. This offers ample scope for growth and ensures continual review of your client database to guarantee freshness and optimised use. ®

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