PerformanceMeasures
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Measuring a Credit Manager's Performance. "Measurement is usually linked to rewards and rewards (explicit or implicit) drive behaviour." (Ron Wells)

Measurement is usually linked to rewards and rewards (explicit or implicit) drive behaviour. Hence Performance Measures are vitally important as a step towards achieving corporate objectives. Therefore Performance Measures should be designed taking into account corporate strategy and objectives.

Generally speaking Credit Objectives align with the overall objective of maximising Total Stockholder Return thus:

Asset Management (ROCE):

        Minimise the Receivable Balance.

        Maximise Cash Flow received.

Costs (Profit):

        Minimise Bad Debts written off.

        Minimise Cost of Capital.

Sales / Turnover (Profit):

        Match the Competition.

        Provide a Competitive Edge.

        Expand the Market.

Most Performance Measures address the first three sub-bullet points only, i.e. minimising the Receivable and the Bad Debt amounts and maximising Cash Flow. However the other value added aspects of the job are equally important and may not receive adequate attention if not measured.

Minimise the Receivable Balance:
Maximise Cash Flow received:
Minimise Bad Debts written off:

A study the following booklet is recommended - available from the NACM Bookstore (http://www.nacm.org/):

Title: An Evaluation of Techniques for Monitoring Accounts Receivable

Author: Dr. George W. Gallinger

Order Code: #151 Price: $25.00 Member Price: $20.00

"This booklet examines 11 different measurement techniques including DSO, ADD and CEI, through the use of a common dataset for sales and accounts receivable and shows you how most techniques fail to solve the sales influence problem. With a better understanding of the shortcomings of the popular techniques, you can improve your organisation's measure of collection performance. A Microsoft Excel-format disk is available to allow you to enter your information into a raw data sheet: number of days in the month, sales for the month, outstanding receivables balances, and the ageing of the balances (in dollars). The software outputs graphs and tables. It's easy to run in Excel (PC version). Booklet, 22 pages, 1995."

This booklet makes it clear that all of the traditional measurement techniques are inadequate and discredited, nevertheless  credit and receivables management professionals generally maintain faith in Days Sales Outstanding (DSO) and/or Collection Efficiency (or some derivative of these). There are four reasons for this;

         firstly, the Credit function usually reports to an executive who is not a credit professional, the Treasurer or Chief Financial Officer, whose accounting or MBA background has instilled a belief in DSO, hence this becomes the imposed measure,

         secondly, some of the traditional methods work satisfactorily in times when turnover/sales Dollars are increasing steadily month by month so they gain false credibility,

         third, computer systems have not been available to handle a better measurement system (based on individual invoices) particularly in high volume situations and

         fourth, if managers use a flawed system they always have a ready excuse for failing to meet their targets.

The last point is not made flippantly. Many people do not like to be measured. Hence they prefer a measurement system which can be challenged when it does not produce a favourable result. Of course it is never challenged when it produces a favourable result.

Minimise Cost of Capital:

Cost of Capital is related to the risk perceptions of a company's potential stockholders and lenders. If Receivables are a significant asset then the 'risk profile' of the Receivable portfolio is an important consideration. Performance Measures should monitor the overall risk profile and should be targeted at maintaining a certain minimum weighted average standard.

The Cost of Capital concept arises out of a study of the risk-to-reward-ratio expectations of the parties that provide business capital.

Lenders (bankers) generally require an interest rate that reflects their internal assessment of the credit risk of a particular loan or financing arrangement. Bond Holders and Commercial Paper investors usually rely on a third party credit rating to provide a risk indication and hence a reward (yield or interest rate) expectation.

These credit risk assessments will take into account the structure of a company's balance sheet (with particular emphasis on leverage i.e. the relative amounts of supplier credit versus interest bearing financing versus equity), the risk inherent in the assets held (including Receivables), management capabilities, business prospects and any collateral offered. Therefore if the Receivable balance is significant the 'risk profile' of the Receivable portfolio will influence the cost of borrowing money to fund business operations and expansion.

Similarly the providers of equity Capital (potential Stockholders) will assess the risk that their investment may be lost, and they will demand an appropriate return. Since Stockholders receive no collateral and must expect to be the last participants to be repaid - should a company fail they will demand a higher return than 'Lenders'. Hence equity Capital is the most expensive form of capital available.

A direct relationship between the cost of capital and the risk profile of the Receivable portfolio is not widely recognised. However this situation could change as service companies become more prominent. Service companies tend to present balance sheets evidencing relatively small amounts invested in Fixed Assets and relatively large Receivable portfolios.

Consideration of Receivable portfolio risk has relatively recently come to prominence in the banking sector. This is due to proposals to reform the Basle Concordat and require banks to reserve capital based on the risk profile of their loan portfolios. Banks must now invent methods to evaluate the risk profile of their portfolios, on virtually a real time basis, in order to satisfy their respective Supervisory Authorities and minimise their Cost of Capital, insuring that returns are maximised.

Match the Competition:
Provide a Competitive Edge:
Expand the Market:

Performance Measures should be tailored to match each company's objectives. An example would be "set up an inventory financing plan to enable distributors to increase purchases by X% in year 2000".


Ron Wells

Copyright 2000  R K Wells

 

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Last Updated:  January 02, 2017 17:18 -0000