It’s Time to Rethink Customer Credit

by Adam Larkin

The days of easy credit are a distant memory for now.  In the early part of the last decade, it seemed as though having a pulse was enough for most banks to offer a new credit line, loan you money for just about anything (including nothing…just borrowed pocket money), and assist your business with various initiatives.  The hard lessons learned in 2008 reminded all of us, including of course banks (who ironically participated in the whole mess to begin with), that thoroughness during the credit analysis process is crucial to the expected payback on any debt.  Extending credit isn’t a fool’s game.  It certainly felt that way for a while, but we now live in an environment where there is an overcompensated obsession with a borrower’s worthiness.  Just ask anyone who has recently purchased or refinanced a home, leased a car, or financed a big screen TV for that matter.  Jumping through hoops and navigating a mountain of paperwork has become the norm.

For businesses, the issue of credit availability is exponentially more challenging.  In an industry such as retail fuels, we are all living in a world where costs are rising interminably and the need for balanced cash flows is mission critical.  Unfortunately, banks seem to be oblivious to the dynamic challenges facing our business and have decided now is a good time to tighten credit restrictions.  Lines are being reduced, new lines are being denied, and folks are being forced to re-apply for existing lines that have not been used extensively.   One has to wonder if a DNA sample will soon be required along with your personal guarantee.

At Hedge Solutions, the nature of our services often leads to direct contact with our client’s banking institutions.  Obviously, the banker’s job is to assess every risk facing the balance sheet of their fuel dealer customers and forward sales are an increasingly hot topic.  Banks know instinctively, and unfortunately by experience, that failing to hedge a committed price program could result in a catastrophic financial mess for a dealer.  We are often called in to affirm that positions are placed and matched to sales.

Almost invariably, another completely unrelated finance topic pops up during the conversations.  Banks are alarmed by the high rate of receivables that fuel dealers carry.  Due to the multi-dimensional character of “receivables”, this can be further broken out by category; the sheer dollar value open, the number of late payers, and most importantly, the inordinately high DSO (Days Sales Outstanding) which is a measure of the average collection time.

But this is not a lesson in cash flow.  That can be saved for your accountants and credit card processors who are the experts in that arena.  The glaringly evident issue coming into focus here is our industry’s legacy of offering credit terms to residential customers.  30 day payment terms have been the norm literally for generations.  In some ways, it feels almost nostalgic, a throwback to simpler times where a handshake meant something and people shuttered at the prospect of not paying their bills.  In other ways, it feels dated and out of sync with the way business is run in the current era of instant consumerism.  If nothing else, it is fairly unique.  It is uncommon to be offered terms for any goods and services these days.  So why do we keep doing it?

There is no doubt that this debate will spark controversy.  The notion of credit terms is woven into the fabric of our industry so one cannot dismiss the importance.  That said, there are two very distinct camps among the dealer network; those that still embrace credit for their customers and those that are doing everything possible to move towards credit cards, EFT, COD, etc.  At our client Round Table meetings in 2012, we spent hours discussing this idea.  To say the conversation got spirited would be an understatement.  Many feel it is a meaningful and permanent part of the full service value proposition.    Just as many feel that it is a risk not worth taking and perhaps the greatest controllable problem facing the industry.

The goal of this article is not to proclaim who is right or wrong but simply to open a dialogue about the possible paths we might take in the context of credit terms.  Are fuel dealers in the financing business?  The answer is yes by standard definition.  Allowing a customer to take possession of fuel or service and pay later is an expensive proposition.  With oil at $4 per gallon and service work at $100 per hour, the hit to the cash flow is not trivial.  And the more costly our products become, the slower people pay.  This only serves to further disconnect the outbound cash from your inbound cash.

Yet, if we stop credit altogether, will customers rebel?  Do they see it as an important part of why they are willing to pay the full service price premium?  For those who have moved away from terms, they will tell you unequivocally “no”.  They will also tell you that the cost of credit card and EFT fees is not only lower than you think but also far less than the cost of bad debt.

Perhaps the answer lies in what Stephen Covey calls “the third option”.  A mix of the two wherein a dealer moves everyone they can to real time payment while maintaining some responsible book of receivables; only offer terms to those who deserve it by way of credit score and/or who have proven worthy of your trust.

Above all, if you decide to continue with terms, never forget the mantra of the credit analyst: “the ability to pay and the willingness to pay are two very different things”.

 

The information provided in this article is general market commentary provided solely for educational and informational purposes.  The information was obtained from sources believed to be reliable, but we do not guarantee its accuracy.  No statement within this article should be construed as a recommendation, solicitation or offer to buy or sell any futures or options on futures or to otherwise provide investment advice.  Any use of the information provided in this article is at your own risk.

 

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