Top 3 Causes for Credit Losses

Bankruptcy, unresolved invoice issues and fraud are the top three causes for credit losses, according to a recent?eNews?poll. By identifying the root cause of credit losses and establishing measures to mitigate risk, credit professionals can prevent future credit losses for their company.

#1 Bankruptcy

Customers filing for bankruptcy was the biggest cause of credit losses over the last three years (34%), according to the poll. Commercial bankruptcies have skyrocketed in recent months to levels not seen since the Great Recession. Chapter 11 bankruptcy filings increased 71% in July year-over-year, according to data provided by?Epiq Bankruptcy.

Even just one customer filing for bankruptcy can have a massive impact on accounts receivable (AR) if that customer makes up a large enough percentage of the portfolio. “We rarely have bankruptcy issues, however, two related companies filed for bankruptcy earlier this summer which resulted in another $90,000 in credit losses,” said Brian C. Diggs, MBA , director of credit at Power & Telephone Supply Company (Piperton, TN).

#2 Unresolved Invoice Issues and Discrepancies

Unresolved invoice issues and discrepancies remain the second highest cause for credit losses over the last three years for 31% of credit departments, mainly due to software or technological advancements. For one NACM member, portals have been a major driver for unresolved invoice issues and discrepancies. “It’s virtually impossible to find someone to correct the issues,” she said.

Rick Wooten CCE / MBA , director of accounts receivable at BG Multifamily (Plano, TX) says the biggest cause for credit losses is billing and invoice delivery challenges as a result of integrating a new billing platform. “Although the platform offered new tools, we did not foresee invoices being billed incorrectly or being sent to the wrong customers,” he said. “By the time the collection team got involved, these invoices were often 60 or more days past due. As in most industries, the older an invoice gets, the more difficult it is to collect.”

#3 Fraud

B2B payment fraud is the third leading cause for credit losses (19%) with the average B2B fraud event resulting in a financial loss of $117,000, according to?Capital One. A?PwC?report found that nearly half of all businesses have experienced fraud, corruption or some other form of economic crime within the last two years, with external perpetrators driving the most considerable risks.

Despite having safeguards in place, credit card fraud is rampant, said Gweneth R. Weeks , operations manager at Big D Concrete Inc. (Dallas, TX). “Unfortunately, we’re unable to track these fraudsters since their contact information becomes disconnected or was never accurate to begin with,” she said. “The chargeback occurs after the deadline to send lien notices, so we are very often outside of our rights to file.” Weeks no longer accepts credit cards for non-account orders and the customer must come to her office and pay in cash or with a cashier’s check.

In the last few years, Diggs’ company has lost roughly $80,000 due to fraud. “I received an application mimicking another company with a slight change in the website,” he explained. “We did not notice the identity theft and shipped the product, which resulted in the loss.”

How to Mitigate Risk for Credit Losses

Credit managers can be proactive in mitigating risk by conducting thorough credit investigations and adhering to Know Your Customer (KYC) practices. “Since not every customer is comfortable sending their financials, we ask them to fill out five metrics from their financial statement,” said Brittany Yvon, CICP CBA , credit manager at OMG, Inc. (Agawam, MA), whose had under $10,000 in credit losses written off in the last year. “The metrics tell me how they run their company, their liquidity, efficiency and profitability. We also keep our aging buckets in 7, 14 and 21 days so if there’s an issue of quantity pricing, like they didn’t receive product, we know within 14 days. That way, we can get that result with the customer up front and we are not waiting until that 30-day mark hits.”

Others, like Wooten, suggest that more credit departments invest in software or technology to protect their company’s largest asset—AR. “The new software we are implementing uses credit scoring to prioritize collections and actively monitors invoices and emails,” he explained. “The customer is assigned a workflow based on credit scores and the higher the risk, the quicker the customer gets to the top of the calling list. These advancements help my collections team focus their time on non-clerical issues.”

Strong creditor-customer relationships are another way to mitigate risk. By strengthening relationships with customers, you open the door for better communication. “We do everything we can to work with the customer so they can be successful which in turn helps us be more successful,” said Theresa Carpenter, credit supervisor at Palmer-Donavin Manufacturing Company (Grove City, OH). “Even after we send out a 10-day demand letter, we ask them to communicate with us because we would rather work with them than for it to go to a collection agency.”

Credit professionals must be wary of potential security, currency or expropriation risk if they have international customers. “I’ve seen an increase in expropriation risk, in which the government interferes with and confiscates from local business and engages in discriminatory practices and expropriation of business, making it impossible for companies to do business in local countries,” said David Kinzel , vice president of structured credit and political risk at Marsh, LLC (Denver, CO) during FCIB’s July?Global Expert Briefing.

Kinzel says this risk will only continue with ongoing world conflict. “For some countries, like Russia, it’s a financial tool to have where instead of declaring war, they take all your companies, assets and intellectual property because it’s physically located in their country,” he said. “This will become a more common theme for North Atlantic Treaty Organization (NATO) countries who operate in Russia that could be taken overseas by the local government and eventually become a great credit loss for some companies.”