Tip: Consider the Management Factor When Making Credit Decisions

There are many things to consider when you evaluate the creditworthiness of a customer. It is important to take a realistic look and go beyond the financial statement, and bureau reports. You have to also evaluate the company's management factor.

The “management factor” relates to how prepared the management team is to run the company. This is a major factor in a company's ongoing success when facing competitive forces, cost concerns, supply chain dynamics, and working capital issues.

The Management Factor

Creditworthiness is driven by the management team's competence, strategies, adaptability, and risk tolerance. To a large part, a company's successes or downturns are the results of management quality, experience, and direction.

• Management drives the quality and competitiveness of the company's product offerings. 
• They determine marketing strategies, how to invest and deploy the company's resources, and how and where a company will compete and grow. 
• Their actions impact the quality of the company's assets, and how are they deployed.

By understanding the quality and actions of a company's management team you will have a window into future performance, and creditworthiness, particularly during economic and competitive headwinds.

Evaluating the Management Factor

• Understand the background and capability of key managers: Whether you are reviewing the creditworthiness of a major account, or a relatively small credit line for a repetitive customer, take the time to evaluate the competence of key managers. Look for:
  • The level of management experience.
  • How long have they been with the company.
  • Their industry experience.
  • A track record of success or failure.
  • Are they open and communicative, or resist providing the information you ask for?

• Compare them with competitors: if your accounts receivable portfolio has competitors in the same industry, channel, or region, how does the management team compare with those of similar companies?

• Performance history: Review the company's past track record of operational and financial performance. Look for examples where management has either taken on risks that failed or due to a lack of flexibility and forward-thinking, the company has fallen behind its competition.

• Ongoing review: Meet with key accounts on a regular basis. If it is a public company, attend or at least be aware of, what is said at annual stockholder's meetings. This will help you understand the company's performance results and business strategies.

• Evaluate management strategies and project results through a realistic lens: 
  • Compare: Are strategies and projected results realistic compared to the competition, business trends, and an uncertain economy? 
  • Consistent: Are projections consistent with past performance trends? 
  • Understand changes in projected results: If you see differences from past trends, question why. There may be new products being launched, an acquisition planned, or some other major change in the business. There may be increased risks. The projections may also simply be unrealistic.

• Are shareholders and management objectives in sync? The objectives, or level of risk tolerance of the company owners, or shareholders may differ from that of the management team. Understand:
  • Short-term vs long-term objectives: Equity holders may be more motivated by short-term shareholder value than longer-term objectives. 
  • Reluctance: New investments and business priorities impacting equity, may be resisted by owners. This can lead to down-range competitive and profitability issues.
  • Reactions driven by past decisions: Shareholders may react negatively to new management initiatives when in the past management has acted too aggressively, launching new products, or moving into new markets or regions, that led to an exit, or restructuring.
  • Shareholder's equity is important to creditors: Watch equity swings. As equity increases, equity holders increase their vested interest in the ongoing success of the company. They take on an increased risk relative to creditors if a company fails. In turn, as equity decreases, creditors take on additional risk if a company fails.

• Leverage your domain expertise: Share your knowledge with the management team, particularly one you see as floundering. You may find a company led by an entrepreneur is growing faster than the management team can handle. 
  • Advise: Cash flow is of critical importance as a company grows. Provide advice on credit and collections policies and staffing. 
  • Compare: Review the balance sheet, P&L, and Cash Flow Statement and trends. If you deal with similar companies, compare the competitor results with others anonymously. This can be revealing to an owner. Inventory or AR turns may be slower than competitors, operational costs may be higher, etc. This information can help guide management to improve performance. Your company will benefit when your customer's creditworthiness improves along with the likelihood they can continue to meet obligations.
  • Stepping in as a trusted advisor brings value: Being a ‘go to' advisor drives customer loyalty and continued business for your company.

Watch our course on How To Take Credit Decisions Using The Porter's Five Forces Model to learn how you could improve your credit decision-making process by applying the Porter's Five Forces model.