will fail to pay, but which will fail and when?
Planning would benefit Credit Risk Management
As amounts of unsecured credit grow ever larger with the
relentless increases in input costs – based on commodity and logistic
shortages – but consumer prices are suppressed by excess supply,
credit managers are increasingly concerned to judge which of their
customers will fail, and when.
question is; should we suffer ‘the slings and arrows of outrageous
fortune, or ... take arms
against a sea of troubles, and by opposing end them?’
TO SEE ARTICLE
AS IT APPEARED IN THE IECA
FALL 2007 JOURNAL
answer is obvious; we cannot sit on our hands while our employer
companies slide toward the waiting abyss of bad debt.
It is incumbent on professional credit managers to find a way to
identify the unfortunate, the badly managed, the naively managed, the
fraudulently managed, and the carelessly managed companies that are
unlikely to survive.
your CFO diligently watches DSO statistics - useless and misleading as
they are – and traditional credit managers rely on the hopelessly
outdated Z-score, or the questionable value of ‘through the cycle’
S&P or Moody’s credit ratings, to foretell the future demise of
this or that counterparty; there is something useful you can do to
prepare the best possible defence for your company.
have all been trained in the traditional art of credit management, with
its emphasis on financial analysis and the scrutiny of umpteen ratios.
All our training and processes are based on the belief that the
future can be extrapolated or ‘foretold’ by looking back at the
past; all are useless in the present environment.
All are built on the erroneous and often disproved assumption
that next year will see progress from the base of last year.
Those rear-view mirror gazers who run so many companies need to
know that ‘change
longer is it additive. No
longer does it move in a straight line.
In the twenty-first century, change is discontinuous, abrupt,
(and) seditious. The age of
progress is dead. We now
stand on the threshold of a new age – the age of revolution.
In our minds we know the new age has already arrived; in our
bellies, we’re not sure we like it.
For we know it is going to be an age of upheaval, of tumult, of
fortunes made and unmade at head-snapping speed. (Leading the
Revolution - Gary Hamel)
future is where we will be paid or not paid by our customers.
Hence as credit managers we need to understand what the future
may hold so we can prepare a range of plans that best fits what
materializes in the fullness of time.
understanding of what the future may hold can be gained through the use
of the Scenario Planning technique.
Scenario planning derives from the observation that,
given the impossibility of knowing precisely how the future will play
out, a good decision or strategy to adopt is one that plays out well
across several possible futures.
These sets of scenarios are, essentially, specially
constructed stories about the future, each one modelling
a distinct, plausible world in which we might
someday have to live and work. (How
to Build Scenarios –
way forward for credit managers then (not being bean-counters of the 19th
century but rather each one being the remarkable synthesis of economist,
commercial lawyer, negotiator, management accountant, business manager,
detective and master strategist) is to create scenarios of the future
for the market or industry in which their customers will be operating.
Then to look back from the vantage point of those futures to
identify which customers are most likely to have failed along the way.
scenario is not a plan, it is not a projection of current trends; yes
the future begins from where we find ourselves today, yes the future is
shaped by forces we see existent today - if we open our eyes wide enough
and shake off assumptions - but it is also shaped by the future actions
of men and women of vision, it is shaped by disruptive technology, and
it is shaped by unexpected pivotal events; like the fall of the Berlin
planning does not offer the security blanket of a single forecast.
it does do is create plausible
'stories of the future'. These
enable one to pick up the signals and search out the clues to the
are learning stories ... the process of working through them
(and) experiencing them, is as important as the conclusions.
(Russia 2010 and what
it means for the World - Daniel Yergin and Thane Gustafson)
is ironic that many of the companies that suffer a sudden reversal of
fortunes are those that up until the onset of their demise are the most
successful in their field. Unfortunately
too many such companies cling on to the formula that created their
success, and institutionalize it when they should be changing as the
competitive environment changes. According
to Robert Heller, writing in The
Fusion Manager, ‘Five Fatal Flaws interplay and interrelate to
produce incompetence and inertia’ within companies that have been
successful. These take root
well before trouble becomes apparent through reported financial results.
Heller lists these flaws as:
Denial: Management has such a high opinion of itself that it cannot accept
criticism of its operations.
The organisation is geared to continuity, not to systematic,
radical improvement and reform.
Bureaucracy: The layers of command and
control slow down reactions.
A rich cash flow cushions any
sense of urgency.
Conservatism: Dissenting voices are
ignored or suppressed by senior managers who are sure that they know
planning cannot provide the sort of precise answers that are available
to those analysts who are looking back into the past, with ratio
calculators in hand. However
as we consider how poorly such precise backward-looking answers have
served analysts in the past we must conclude that a new approach is
required. How many of the
Rating Agencies and traditional credit managers predicted the
spectacular failures of recent history, before it was too late for
hapless creditor companies and banks?
good conscience we cannot cling on to precision in the same way as an
insecure child clings to a tatted piece of rag, we must explore new
methods to enable the support and promotion of our companies’ sales;
while protecting their future survival.
is not good enough after a bankruptcy occurs to say; ‘the ratios were
good, and they always paid on time’.
Rather be the credit manager to say, ‘their strategies didn’t
make sense in terms of any reasonable future scenario, and their
business model was inflexible, so we withdrew open credit months ago’.
Ron Wells is the author of Global Credit
Management - an Executive Summary, published
by John Wiley & Sons Limited.
This is a concise but authoritative work that exposes the
power of credit, see www.barrettwells.com/gcm.html
for details. The Chinese version of this book has now been published, it is an ideal
gift for Chinese business executives of all types; Chief
Executives (CEOs), Chief Financial Officers (CFOs), Treasurers,
Credit Managers, Entrepreneurs starting or running their own
businesses, and students of business practice preparing to face
the tough challenges of business management, see www.barrettwells.com
is an active member of the International Energy Credit
Association (IECA) and the Association for executives working in
Finance, Credit and International Business (FCIB).
His free access international credit management web site
www.barrettwells.co.uk is highly regarded as a valuable resource
for those interested in trade finance and business-to-business
email address is: firstname.lastname@example.org.