Is the Covid 19 Economy a Sales Opportunity?
Introduction:
For most companies, the Covid 19 Economy will cause revenue reductions and cash shortages far worse than prior recessions in this country. Two major changes affecting the management of credit risk for most companies will be:
a. You will have more customers file bankruptcy
b. You will be compelled to sell to uncreditworthy customers on credit, to achieve breakeven sales volumes
How will your company survive under these conditions?
In addition to: (1) an updated assessment of credit risk in your customer base, and (2) well executed credit controls and collection protocols, part of the solution will be to sell to new customers. The challenge is:
a. How much can be sold to High Risk customers and especially new customers?
b. How do we determine who are the “right” new customers to onboard?
Objective and Actions:
The primary objective in this economy is to sell and collect enough to enable a positive or at least breakeven, cash flow. How can this be achieved?
The first step is to update the credit risk assessment of all your customers, and classify them into Low, Medium, and High Risk categories. Forecast sales (realistically) to the Low and Medium Risk categories for the next 12 months. Then estimate how much you have to sell to High Risk customers to break even.
The second step is to forecast the cash receipts and ending Accounts Receivable (AR) balances for the next 12 months, using realistic estimates of how much of the AR will be paid and how slowly. Run several scenarios with varying assumptions. For example, we ran a plausible scenario through our AR and Cash Receipt Forecast Model which contained substantial sales to the High Risk segment. After 12 months, the results were:
a. 45% of total AR owed by the High Risk segment
b. DSO increased by 38% or one month sales, so one month of cash moved from the bank account to the AR ledger
c. 16% of total AR being over 120 days past due
Clearly, not a desirable outcome, but one that illustrates the perils of relying too heavily on the High Risk customers. In such a scenario, it may be prudent to reduce sales to the High Risk segment and even accept below-breakeven sales for a while to avoid catastrophic bad debt losses in the future.
However, for some companies, sales to Low and Medium Risk companies will be sufficient to break even. These companies can constrain sales to High Risk customers to a low level. It is for these companies, that the Covid 19 economy will be a sales opportunity!
How to Optimize Sales Opportunities during the Covid 19 Economy
First, sell all you can to the Low and Medium Risk categories (most of whom will still require diligent monitoring of their AR). Remember, some of these will lapse into the High Risk category via slow/limited remittances to you, or by updated credit assessments (which must be done monthly).
Then carefully evaluate:
a. how much you can afford to sell to High Risk companies
b. which High Risk companies to whom to sell
Utilization of an AR and Cash Flow Forecast Model will enable you to quantify how much you can prudently sell to High Risk customers without accumulating an unacceptable bad debt risk. In essence, this will be a quantification of how much you can invest in receivables owed by High Risk customers. It will be an estimate of your company’s “High Risk Credit Fund” which will be similar to a Venture Capital Fund, without the fabulous multiples in paybacks that venture capitalists enjoy on some of their investments. These fabulous paybacks cover the cost of the failed venture capital investments. Your payback will be sales and cash flow (risky and probably delayed in the short term) from High Risk customers who survive, then hopefully flourish to become your larger, higher growth “customers of the future”. It is entirely appropriate and advisable to charge these High Risk customers higher prices to reflect a risk adjusted margin on your sales to them.
To decide which High Risk customers to whom to sell, rank the existing and new High Risk customers according to:
a. Do they have a decent chance to survive the Covid 19 economy?
b. Do they have high growth potential during or after the Covid 19 economy recovers? Will they become among your larger customers in the medium term future?
Remember, you will likely have a number of long term High Risk customers that you will wish to support with extension of credit, out of loyalty or according to your company’s culture/ethos. Ultimately, this will have to be resolved by Senior Management in what will undoubtedly be a very difficult decision. There’s no sugar coating the difficulty of such decisions, but they have to be taken to provide direction in executing the program needed to ensure your organization’s survival.
Optimally, you will sell (and invest your High Risk Credit Fund) to those limited High Risk customers that have the potential to be larger, faster growing, higher margin customers of the future. While you will have some existing High Risk customers who meet these criteria, this is where the opportunity to onboard new customers emerges, and where the Covid 19 economy becomes a sales opportunity.
The opportunity to sell to new customers will manifest itself in two ways:
a. new customers who submit orders to you, unsolicited by your Sales Team
b. targeted new customers solicited by your Sales Team
Unsolicited New Customers:
Beware. Why are they coming to you? In many cases, it is because they have been shut off or substantially constrained from buying on credit from the current suppliers. If they are rated Low or Medium credit risks by your Credit Department, accept them, but proceed with caution with limited amounts of credit. Then monitor their payment performance and creditworthiness closely. Another reason is maybe one of their suppliers went out of business. If so, a little good luck never hurt.
If they are rated High Risk by your Credit Department, then assess their growth potential and survival prospects. If acceptable, extend them a small line of credit and monitor closely. If unacceptable, offer Cash in Advance terms, which will probably kill the deal. If they accept, work carefully with them to extend limited amounts of credit. Remember, your company’s High Risk Credit Fund is limited.
Solicited New Customers:
These must be vetted for sales potential and credit risk acceptability prior to solicitation. Don’ t waste time on companies to whom you are not prepared to extend some level of credit. Here again, for these customers, treat them based on their credit risk category as outlined in the prior section.
Credit Controls:
The foundation for the actions described above is strong credit controls. Current risk ratings, refreshed monthly, are the foundation for allowing sales. Credit limit and delinquency controls, supported by frequent monitoring of exposure and timely collection contact, will enable your organization to generate the cash flow required, while controlling (not eliminating) severe delinquency and bad debt loss.
Decisive, quick action will be required to control losses in a fast changing economic environment. Note that frank and frequent communication is essential to making this work with your customers. This is labor intensive, so plan accordingly.
Finally, ensure that your organization’s posture to the market and your customers is understood by all who have customer contact. The posture will very different from the one that existed three months ago. Many customers will be unhappy with the actions taken to enable your company to survive. Customers need to hear a consistent message from everyone to whom they speak at your company.
Life on the Other Side:
When the economy recovers, you can be in an enhanced position to enjoy higher levels of revenue, profit and growth. You can have significant new customers who add a material level of sales, at higher margins, and who have a strong loyalty to you for working with them in a difficult economy.
Conclusion:
Yes, the Covid 19 Economy can be a sales opportunity for companies that have a solid baseline of sales to lower credit risk customers. Those customers’ remittances will provide adequate cash inflow to sustain operations.
This cash inflow provides an opportunity to extend credit judiciously to risky but high potential new customers when needed. New customers will be of two types:
a. companies with mediocre to excellent credit – these can be readily accepted with proper limits and controls
b. companies with poor credit
By establishing a High Risk Credit Fund and exercising strong Credit and Collection protocols, you can reap profitable sales from financially weak new customers, while managing losses from bad debt and delinquency. Hopefully, a number of these High Risk new customers will survive and flourish, increasing your medium term revenue and market share.