As credit professionals in today's rapidly changing business credit environment, we are continually challenged to provide more with less. I'm going to discuss a subject that clearly makes some credit managers' blood boil: credit scoring.
The reason I promote business credit scoring is quite simple: it works. Everyone has a different definition of credit scoring. Here is mine. Commercial credit scoring is a combined judgmental and statistical model that assists today's proactive credit managers in their credit decision-making. There are three types of models: Custom, Generic, and Vendor Models. Depending on your industry and company, I recommend looking into all three.
I will not go into the description of each of these in detail, as there are numerous articles on www.CreditToday.Net that go into great detail about how they are made and what they do.
What I will do is give you several case studies of real-world companies that I have worked for in which I was deemed a stronger member of the management team because I used credit scoring as one of my major tools to clean up the credit process. The emphasis will be on the opportunities I saw to use credit scoring and the obstacles I faced.
Case 1: Largest Money Order Company in the US
Situation
· Annual Sales $580 million
· Aged accounts prior to credit scoring $15 million
· Losses very large
· Sells to Proprietorships and partnerships (small convenience stores, party stores, and liquor stores).
· Exposure: A huge exposure, as the client sells money orders raging from $5 to $10,000 and expects repayment on a weekly basis.
· Program initiated: 1991
Opportunities
The credit approval process prior to credit scoring was cumbersome, labor-intensive, and expensive, involving 16 credit analysts plus support personnel. We needed lower costs per transaction, substantially quicker turnaround time, and we needed to control credit issued based on the economy and parameters established by the credit committee.
Issues/Obstacles
·No other industries were reporting on the proprietorships or partnerships.
·Would our trade tapes be safe?
·What if we report the wrong information?
·What would it cost?
·Why hasn't some other company done this before?
·Which type of model should we use?
·How accurate will the scores be?
We analyzed the opportunities and determined that the process improvement and increased cash flow could outweigh the obstacles and issues, so we addressed those first.
· Industry is not participating? The majority in this industry are now participating.
· Why hasn't our competition done this before us? We are the industry leader and whatever we do they will follow.
· Are the trade tapes safe? In 10 years there has been no breach of security.
· How accurate would the scores be? 98.7 percent at predicting a loss and slow pay.
· What if we report wrong information? The numbers spoke for themselves: they came right off our aging report. What will it cost? Back then it cost $180,000
· Which model should we use? We had three credit reporting agencies. We took "Retro score" year-old accounts, with year-old information and had them "predict" which accounts would go bad. We chose to blend commercial and consumer scores and then add our "in-house" credit information.
Results
· The 16 credit analysts are now 2 · Turnaround time was cut by 6 days to 1 day · Aged receivables were lowered, and are maintained 85 percent lower · Losses dropped by 90 percent to less than $1 million without reducing market share.
Case 2: Largest Convention Service Contractor in the US
Situation
· Annual Sales: $650 million, aged accounts prior to credit scoring $15 million.
· Losses: Substantial
· DSO: Extremely high for a service-related business.
· Sells to Virtually every industry group in the world.
· Proprietors and Partnerships, 25 percent
· Corporations: 75 percent
· Average transaction size: $1,000.
· Expects payment: Upon rendering of services or net 30 days on credit clients.
Opportunities
· Lower the number of clients "taking" credit.
· Lower DSO substantially
· Increase cash flow.
Obstacles/Issues
Same as above: · Why are competitors not doing it? · Are the tapes safe? · Accuracy concerns. · What will it cost? · Thousands of clients ·Which model to use?
Results
· No breach in safety
· No accuracy concerns
· Costs, $30,000 for both vendors
· We used both Experian and D&B vendor models, primarily their small business credit scoring reports.
· Aged receivables dropped from over $15 million to less than 10 percent
· Losses dropped by 80 percent
CASE 3: Largest Fire Protection and Sprinkler Contactor in the US
Situation
· Annual sales $800 million
· Region's sales $250 million
· Aged accounts $53 million
· Losses: Not a large percent of receivables
· DSO: 50 days higher than the industry average
· Average transaction size: $1000
· Payment terms: Net 30 days
Opportunities
· Fewer clients taking terms
· Lower DSO
· Increase cash flow
Issues/Obstacles
· Good old boy business mentality
· Why aren't competitors' credit scoring? Are tapes safe?
· Unique features of this industry: The construction industry is very "tight-lipped" regarding payment terms and customer information. "Been doing business with them for years," expresses the mentality.
"Paid when and if Paid" clauses are normal.
"We will lose the work if we force them to pay" is a common attitude.
Overcoming these obstacles was tough. However, what we did was retro-score-year-old accounts again, and the results we received were again excellent at predicting losses.
· We have requested credit scores on new clients.
· We use credit scoring to make a decision to pursue legal action or use a collection agency.
· We have suggested the use of credit scoring to our NACM credit group, and they have taken the suggestion "under advisement."
Conclusion
I have used credit scoring "because it works." In three separate industries, there were three comparable results:
· Lower overall costs
· Lower delinquencies
· Lower DSO
Credit scoring is a tool, and like any tool, it is only as good as the person who is using it. I have used it for 11 years in the commercial credit industry and will continue to use credit scoring because it has helped me and the companies that I worked for to be more profitable.
Tools such as credit scoring, along with solid fundamental credit knowledge, can only enhance the performance of credit professionals. As we are all aware, in today's rigorous business environment every sale is important, but the transaction is not complete until the money is in the bank. It continues to amaze me when I see the number of effort companies take in order to make a sale, only to allow the back end of the process, credit granting, to be an afterthought. Credit scoring is now a proven technology. Maybe it's time for you to put it to good use.
