Tag Archives | credit

Accounts Receivable Collection Letter

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Collect accounts receivable
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Accounts Receivable Collection Letter

Always send reminder and collection letters. Letters combined with calls can help speed up your collections! Trigger points for letters may be as follows:

Balance at 30 days receives a reminder letter. Then balance at 60 days receives a harsh collection letter and credit hold. Then balance at 90 days receives attorney letter. Finally, balance at 110 days turned over to collections.

The number of collection letters in a series should be kept to a minimum. Experienced commercial credit grantors have found that there is a point of diminishing returns, generally reached after the first letter goes unanswered.

(NOTE: Want the 25 Ways To Improve Cash Flow? It gives you tips that you can take to manage and improve your company’s cash flow in 24 hours! Get it here!)

Example of Accounts Receivable Collection Letter

Remind Letter Example A:

January X, 20XX

Dear Company A,

This is a friendly reminder that your account has a past due balance of $X.xx. Attached are the invoices we show to be unpaid; please check your records and if you find that these have already paid, please contact me at 713-555-5555.

If we do not hear from you or receive payment within 10 days from the date of this letter, your account will be put on credit hold and no further services will be provided until all overdue balances are paid in full.

Thank you for your prompt attention to this matter.

Sincerely,

Collections Representative

A reminder letter, signed by the accounts receivable (AR) collections representative, once a balance has reached 30 days old and a subsequent, harsher collection letter when a balance reaches 60 days can produce desired results. Should the harsh collection letter not produce results, an attorney letter may be in order as well as the services of a collection agency. The following example is of a harsh collection letter which should be signed by the company’s controller.

Remind Letter Example B:

February X, 20XX

Dear Company X:

We show your account has a past due balance of $X.xx. Previous attempts to collect the balance have failed and as a result, I have been forced to put your company on credit hold. Please call me immediately at 713-555-5556 to resolve the balance on your account and to avoid having this issue referred to a collection agency.

Sincerely,

Controller

Managing accounts receivable and collecting on-time is just one of the many ways to improve cash flow. The next step to improving cash flow is to download the free whitepaper, 25 Ways to Improve Cash Flow.

accounts receivable collection letter

accounts receivable collection letter

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5 Cs of Credit (5 Cs of Banking)

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What are the 7 Cs of banking
How to Manage Your Banking Relationship
Line of Credit
Trade Credit
Collateralized Debt Obligations

5 Cs of Credit (5 Cs of Banking)

The 5 Cs of credit or 5 Cs of banking are a common reference to the major elements of a banker’s analysis when considering a request for a loan. Namely, these are Cash Flow, Collateral, Capital, Character, and Conditions. Below is an in-depth description of each of the 5 Cs of credit or banking to help you understand what your banker needs to understand about your business in order to approve your loan. You will have insight as to where your banker is coming from and will therefore better prepare you to handle their questions and concerns.

Cash Flow
Collateral
Capital
Character
Conditions

Cash Flow Importance

Cash Flow After Tax is the first “C” of the 5 Cs of credit (5 Cs of banking). Your banker needs to be certain that your business generates enough cash flow to repay the loan that you are requesting. Therefore, your banker will be looking at your company’s historical and projected cash flow and compare that to the company’s projected debt service requirements. There are a variety of credit analysis metrics used by bankers to evaluate this, but a commonly used methodology is the “Debt Service Coverage Ratio” generally defined as follows:

Debt Service Coverage Ratio = EBITDA – income taxes – unfinanced capital expenditures divided by projected principal and interest payments over the next 12 months

Generate more cash flow in your company with our free 25 Ways to Improve Cash Flow whitepaper! You can access it by clicking here.

Historical Ability to Service Debt

Typically, the bank will look at the company’s historical ability to service the debt. Your company’s past 3 years free cash flow will be compared to your projected debt service. In addition, they will compare free cash flow to the past twelve months to the extent your company is well into its fiscal year. While projected cash flow is important, the banker will generally want to see that the company’s historical cash flow is sufficient to support the requested debt. Usually projected cash flow figures are higher than historical figures due to expected growth at the company; however, your banker will view the projected cash flows with skepticism as they will generally entail some level of execution risk.

If your historical cash flow is insufficient, the banker must rely on your projections. Therefore, you must be prepared to defend your future cash flow projections with information that would give your banker visibility to future performance, such as backlog information.

Margin of Error

The banker will also want a comfortable margin of error in the company’s cash flow.

A typical minimum level of Debt Service Coverage is 1.2 times.

This means that the company is expected to generate at least $1.20 of free cash flow for each dollar of debt service. This margin of error is important. The banker wants to be comfortable. If there is a blip in the company’s performance, they want to know that the company will still meet its obligations.


Click here to Download the 25 Ways to Improve Cash Flow


Importance of Collateral

In most cases, the bank wants the loan amount to be exceeded by the amount of the company’s collateral. The reason the bank is interested in collateral is because it acts as a secondary source of repayment of the loan. If the company is unable to generate sufficient cash flow to repay the loan at some point in the future, the bank wants to be comfortable that it will be able to recover its loan by liquidating the collateral and using the proceeds to pay off the loan.

Assess Available Collateral

How doest the banker assess your company’s available collateral? It is common place for borrowers to think that the bank will lend a dollar for every asset that their company owns. This is not the case.

Certain Asset Classes

First, the banker is interested in only certain asset classes as collateral – specifically accounts receivable, inventory, equipment and real estate – since in a liquidation scenario, these asset classes can be collected or sold to generate funds to repay the loan. The banker will not consider other asset classes as collateral. Since in a liquidation scenario, they would not fetch any meaningful amounts. These asset classes include goodwill, prepaid amounts, investments, etc.

In the case of accounts receivable, the debtor (your company’s customer to whom a good was sold or service rendered) is legally required to pay their bill with the company, and in a liquidation scenario the bank will collect the accounts receivable and use those amounts to pay down the loan. In the case of inventory, equipment and real estate, the bank can sell these assets to someone else and use the proceeds to pay down the loan.

Historical Liquidation Values

Secondly, the bank will discount or “margin” the value of the collateral based on historical liquidation values. For example, bank’s will generally apply margin rates of…

  • 80% against accounts receivable
  • 50% against inventory
  • 80% against equipment
  • 75% against real estate

These advance rates are not arbitrary. These are the amounts that in the bank’s historical experience they have realized in a liquidation scenario against the respective asset class. While you might think that your accounts receivable would collect 100% on the dollar, the amounts have actually been historically closer to 80%. In liquidation scenarios, account debtors will come up with reasons why they don’t owe the entire amount. Or worse, they won’t pay at all and force the bank to sue them for collection.

The amount of the receivable would be exceeded by the legal costs of collection in some cases, and thus the bank simply won’t pursue collection. In the case of inventory, 50 cents on the dollar is usual since the buyers of this inventory know that it is a distressed sale and are in a position of leverage to buy the goods for less than what it cost you to buy them.

Third Party Appraisals

In the case of equipment and real estate collateral, the bank needs a completed third party appraisal on these assets. The bank will margin the appraised value of these asset classes to determine the amount of the loan… As opposed to using the company’s carrying value of these assets on its balance sheet. You will be responsible for the cost of third party appraisals. So, be sure to factor in the time needed to complete the appraisals.

Due Diligence

Also, the bank will in many cases want to complete due diligence on your accounts receivable and inventory to confirm asset values as well as the reliability of the reports you provide to the bank. This due diligence is called a “collateral exam” or “field audit”, and involves the bank sending an auditor to the company’s offices to review books and records to:

(1) Ensure that the company-generated reports for accounts receivable (your accounts receivable aging) and inventory are accurate and reliable

(2) Determine and confirm the amounts of any “ineligibles” within these asset classes.

In general, ineligibles are amounts that the bank will not lend against. This includes the following:

  • A/R over 90 days past due
  • Accounts that are due from foreign counter-parties
  • Accounts that are due from counter-parties that are related by common ownership to your company

In the case of inventory, ineligibles will generally include any work-in-process inventory, any consignment inventory, and inventory that is in-transit or otherwise not on your company’s premises.

Importance of Capital to Banks

When it comes to capital, the bank is essentially looking for the owner of the company to have sufficient equity in the company. Capital is important to the bank for two reasons…

First, having sufficient equity in the company provides a cushion to withstand a blip in the company’s ability to generate cash flow. For example, if the company were to become unprofitable, then it would burn through cash to fund operations. The bank is never interested in lending money to fund a company’s losses, so they want to be sure that there is enough equity in the company to weather a storm and to rehabilitate itself. Without sufficient capital, the company could run out of cash. Then they would be forced to file for bankruptcy protection.

Secondly, when it comes to capital, the bank is looking for the owner to have sufficient “skin in the game”. The bank wants the owner to be sufficiently invested in the company such that if things were to go wrong, the owner would be motivated to stick by the company and work with the bank during a turnaround. If the owner simply handed over the keys to the business, then the bank would have fewer, less viable options to obtain repayment of the loan.

Debt to Equity Ratios

There is no precise measure or amount of “enough capital”, but rather it is specific to the situation and the owner’s financial profile. Commonly, the bank will look at the owner’s investment in the company relative to their total net worth, and they will compare the amount of the loan to the amount of equity in the company – the company’s Debt to Equity Ratio. This is a measure of the company’s total liabilities to shareholder’s equity.

Remember, banks typically like to see Debt to Equity Ratios no higher than 2 to 3 times.

Conditions

Another key factor in the 5 Cs of credit is the overall environment that the company is operating in. The banker assesses the conditions surrounding your company and its industry. They determine the key risks facing your company. They also determine whether these risks are sufficiently mitigated. Even if the company’s historical financial performance is strong, the bank wants to be sure of the future viability of the company. The bank won’t make a loan if your company is threatened by some unmitigated risk not sufficiently addressed. In this assessment, the banker is going to look to things such as the following:

The Competitive Landscape of Your Company

Who is your competition? How do you differentiate yourself from the competition? How does the access to capital of your company compare to the competition and how are any risks posed by this mitigated? Are there technological risks posed by your competition? Are you in a commodity business? If so, what mitigates the risk of your customers going to your competition?

The Nature of Your Customer Relationships

Are there any significant customer concentrations (do any of your customers represent more than 10% of the company’s revenues?) If so, how does the company protect these customer relationships? What is the company doing to diversify its revenue base? What is the longevity of customer relationships? Are any major customers subject to financial duress? Is the company sufficiently capitalized to withstand a sizable write-down if they can’t collect their receivable to a bankrupt customer?

Supply Risks

Is the company subject to supply disruptions from a key supplier? How do they mitigate any risk? What is the nature of relationships with key suppliers?

Industry Issues

Are there any macro-economic or political factors affecting, or potentially affecting the company? Could the passage of pending legislation impair the industry or company’s economics? Are there any trends emerging among customers or suppliers that in the future will negatively impact operations?

Drivers of Business

The banker will need your help to identify and understand these key risks and mitigants, so be prepared to articulate what you see as the primary threats to your business, and how and why you are comfortable with the presence of these risks, and what you are doing to protect the company. The banker will need to understand the drivers of your business, which is equally as important to the banker as understanding the company’s financial profile.

Character

While we have left “Character” for last, it is not the least important of the 5 Cs of credit. Arguably it is the most important. Character gets to the issue of people – are the owner and management of the company honorable people when it comes to meeting their obligations? Without scoring high marks for character, the banker will not approve your loan.

How does a banker assess character?

Character is an intangible. It is partly fact-based and partly “gut feeling”. The fact-based assessment involves a review of credit reports on the company, and in the case of smaller companies, the personal credit report of the owner as well. The bank will also communicate with your current and former bankers. They want to determine how you have handled your banking arrangements in the past. The bank may also communicate with your customers and vendors. This is to assess how you have dealt with these business partners in the past. They will determine the soft side of character assessment by how you deal with the banker during the application process. Thus, their resultant “gut feeling” will be a determining factor.

Bankers Want to Deal With Trustworthy People

In the end, bankers want to deal only with people that they can trust to act in good faith at all times – in good times and in bad. Banks want to know that if things go wrong, that you will be there. They want to know that you will do your best. In addition, they want to ensure that the company honors its commitments to the bank. Even if the company’s financial profile is strong and scored well in all of the other 5 Cs of credit, the banker will reject the loan if they fail the character test. To be clear – it is not necessarily an issue if your company has gone through troubled times in the past. What is more important is how you dealt with the situation.

Were you forthright and proactive with the bank in communicating problems?

Or did you wait until a default situation was already in effect before reaching out to the bank?

Were you cooperative with the bank while getting through the distressed period?

We cannot stress enough the importance of character.

Five Cs of Credit Management

To summarize, the 5 Cs of credit forms the basis of your banker’s analysis as they are considering your request for a loan. The banker needs to be sure that (1) your company generates enough CASH FLOW to service the requested debt, (2) there is sufficient COLLATERAL to cover the amount of the loan as a secondary source of repayment should the company fail, (3) there is enough CAPITAL in the company to weather a storm and to ensure the owner’s commitment to the company, (4) the CONDITIONS surrounding your business do not pose any significant unmitigated risks, and (5) the owners and management of the company are of sound CHARACTER, people that can be trusted to honor their commitments in good times and bad.

Hopefully, this article has succeeded in helping you understand where your banker is coming from. With a better understanding of how your banker is going to view and assess your company’s creditworthiness, you will be better prepared to deliver information and position your company to obtain the loan that it needs to grow and thrive. You should use these 5 Cs as a credit management tool to run your company. To improve your cash flow, download the free 25 Ways to Improve Cash Flow whitepaper.

5 Cs of credit, 5 Cs of Banking

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5 Cs of credit, 5 Cs of Banking

 

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2/10 Net 30 Example

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2/10 net 30

2/10 Net 30 Example

Mary has started a processing plant for natural vegan snacks. In her business, equipment does all of the heavy lifting that human resources can not. Mary has purchased many pieces of equipment. One of these is a large oven to bake her healthy snacks in. She has been offered 2/10 net 30 payment terms.

She purchased this oven 7 days ago and is already selling her treats at a very fast pace. Mary already has the cash to pay her invoice in full. She wants to evaluate the benefits of 2/10 net 30 terms of payment.

Details

The invoice amount is $10,000 and 2/10 net 30 accounting is in place.

If paid within 10 days: $10,000 X 98% = $9,800 due with in 10 days

If paid within 30 days: $10,000 is due

Calculation

Mary likes that she can receive a $200 value by paying her bill quickly. Then, she finds a catalog which offers a tool that will speed the preparation time of her products by employees. Knowing her business quite well, she estimates that preparation time of one full box of her snacks will be cut by 2 hours. This leaves 5 hours of preparation time remaining.

Mary also knows that 6 employees usually work on one full box of treats. These employees receive $10/hr in wages. This means that she can save $120 on just one box of her products. The calculation is done below:

Normal preparation time: 7 hours of work X $10/hr X 6 employees = $420 to prepare one box

Preparation time with the tool in question: 5 hours of work X $10/hr X 6 employees = $300 to prepare one box

Mary is selling boxes at an extremely fast rate. If this continues, which Mary expects, she will quickly save more money by buying the new tool than paying the bill on the oven within 10 days. She appreciates the 2% discount but decides against it. Mary buys the tool and quickly makes more money than she would have saved with the credit terms of 2/10 net thirty.

For more ways to add value to your company, download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

2/10 net 30 example

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2/10 net 30 example

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The 5 C’s of Banking

“The “5 C’s of credit” or “5 C’s of banking” are a common reference to the major elements of a banker’s analysis when considering a request for a loan. Namely, these are Cash Flow, Collateral, Capital, Character and Conditions. This article will provide an in-depth description of each of the 5 C’s of credit or banking to help you understand what your banker needs to understand about your business in order to approve your loan. By the end of this article, you will have insight as to where your banker is coming from. As a result, it will better prepare you to handle their questions and concerns.

The 5 C’s of Banking – Cash Flow Importance

Cash Flow is the first “C” of the 5 C’s of Credit (5 C’s of Banking). Your banker needs to be certain that your business generates enough cash flow to repay the loan that you are requesting. In order to determine this, the banker will be looking at your company’s historical and projected cash flow and compare that to the company’s projected debt service requirements. There are a variety of credit analysis metrics used by bankers to evaluate this. A commonly used methodology is the “Debt Service Coverage Ratio” generally defined as follows…”

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

5 C's of Banking
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5 C's of Banking

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Personal Credit: How Important For Business Loans?

Often business owners go to great lengths to pay the company’s bills on time. Often at the expense of their not taking a salary. When cash is tight which is more important; your company credit rating or your personal credit rating and why?

Personal Credit: How Important For Business Loans?

Bankers don’t like it but they understand when the economy goes south. Sometimes businesses can’t meet their financial obligations and need their banker to work with them. It is at these times that the banker resorts to the Five C’s of Credit for evaluating the risks.

When collateral is not there, nor the cash flow, the banker looks to the character of the borrower. The best indicator of a borrowers’ intent to repay is their personal credit history. If you keep your personal credit squeaky clean then you will probably do the same with your business credit once the economy returns.

So as you work with your companies to either maintain your business credit or obtain new credit sources make sure that the owners are maintaining their credit ratings.
Personal Credit: How Important For Business Loans?

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The 5 C’s of Credit

The 5 C’s of credit or 5C’s of banking are a common reference to the major elements of a banker’s analysis when considering a request for a loan.

The 5 C’s of Credit

Namely, these are Cash Flow, Collateral, Capital, Character and Conditions. This article will provide an in-depth description of each of the 5 C’s of credit or banking to help you understand what your banker needs to understand about your business in order to approve your loan. By the end of this article, you will have insight as to where your banker is coming from. Therefore, it better prepare you to handle their questions and concerns…

More at WikiCFO.com

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

5 C's of credit
Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

5 C's of credit

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Banks Tighten Credit Standards

An article in todays’ Wall Street Journal highlights how banks tighten credit standards across the country’s banking community. The author cites interviews with bankers indicating a change in the amount of risk that lenders are willing to take. Later in the article the author cites sources that say they haven’t seen a credit crunch. So which is it?

Banks Tighten Credit Standards

The short answer is that it depends on your local market. How is the local economy performing and how competitive is your banking community? Regardless of the current lending environment you can count on banks‘ underwriting to become more conservative. Why? Because the federal banking regulators will begin to tighten the rules for the entire banking community not just local markets.

Prepare for This Changing Environment

As a CFO or controller how can you prepare for this changing environment? The best way is to get your financial house in order. Improve your cash management reporting. Prepare a cash flow projection to give to your banker. Prepare a strategic plan to manage and predict your capital needs months in advance. Finally, take your banker to lunch. Let him know what is happening in your business so there will be no surprises.

By improving your cash management tools, forecasting your needs and communicating with your banker you can actually weather the coming credit crunch.

Download your free External Analysis whitepaper that guides you through overcoming obstacles and preparing how your company is going to react to external factors.

Banks Tighten Credit Standards

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

Banks Tighten Credit Standards

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LEARN THE ART OF THE CFO