Written By: Steve Kailas, Esq. and Stephen Taylor, Esq.
Kohner, Mann & Kailas, S.C.
Since late spring, there has been increasing speculation that the world economy is teetering on the edge of a second recession. Certainly, the United States economy has been torpid since late spring and Chinese manufacturing output appears to have slowed since midsummer. Meanwhile, European countries are in the midst of a crisis of confidence over debt and the largest economy, Germany, seems to be faltering. Though it is too early to tell whether we have slipped into a second, or “double-dip”, recession, many businesses appear to be gambling that we have not, perhaps not realizing the true significance of the stakes involved. This may be a big mistake.
A “double-dip” recession represents “a worst-case scenario” for business. The brief period of growth between “dips” means that most businesses and consumers will not have the time to replenish their reserves. Few will doubt the impact of the recent recession. A renewed period of austerity can further strain the already depleted resources of many businesses and their customers. Though double-dip recessions are rare (the last occurred in the United States in the early 1980s), most analysts hold that the balance of probabilities is that the economy of United States has entered a period of negligible growth even if it is not experiencing the negative growth of the second “dip” recession.
Coming hard on the back of the last recession, even a prolonged slowdown could prove perilous for businesses. The sucker punch is the legacy of the brief positive spell before the renewed downturn. When businesses see a potential upturn, they tend to start expanding inventory and investing in equipment and labor. After all, one cannot take advantage of rising demand without the means to satisfy it. If a double-dip does strike, such businesses are left with increased accounts payable and overheads, and depleted reserves, but without the necessary ability to generate sales and profits.
The result is that business debt increases and becomes delinquent, and debt recovery rates fall. In such circumstances, the early bird gets the worm. Businesses that allow customers to extend payment periods risk extending delinquencies into dangerous waters. When reserves are down and liabilities are up, only those creditors that enforce payment of delinquencies get paid. Since business creditors themselves owe debt to others, if their receivables erode so does their working capital, along with their ability to service their own obligations, all of which perpetuates the cycle of decline.
In the United States the consensus is that one of the prime reasons for the lack of job creation is that businesses are stock-piling cash or near-cash assets in case of further economic turmoil. Yet, seemingly in direct contradiction, the debt liquidation industry is reporting that too many businesses have neglected and relaxed their focus on debt collection because the economic news brightened somewhat. Many continue to delay acting to recover on delinquent accounts despite recent poor economic news. This is in spite of the generally recognized fact that, in the short-to-medium term, one of the best means to improve the financial strength of any enterprise is by converting receivables into cash in the bank.
While referred to as assets in accounting terms, accounts receivable only represent a paper gain: only banked income shows up in an income statement. The value of outstanding receivables is actually the amount due on paper less a percentage discount derived from historical payment rates. This makes recovery performance particularly significant since by raising recovery rates, one not only increases real income, but also the balance sheet value of owners’ equity. This in turn has a significant impact on the cost of financing (borrowing) and, perhaps more significantly given the current tight business credit environment, on the ability to secure funding. Actually, the effect is multiplied because more effective conversion of accounts receivable directly increases available working capital, and thus affects the need for financing and the asset to loan ratio.
The time to act is now! Whether it is a question of enforcing existing policies more proactively or of amending credit policies and procedures to reflect the current economic climate, acting now to educate customers could yield major dividends. Recall the advice of long-time Chairman and CEO of GE, Jack Welch: “Control your own destiny or someone else will.” If the economic malaise continues, the window of opportunity will diminish. Additionally, in comparable periods in the past, the tendency has been for stakeholders to ask why such actions—obvious with the aid of hindsight—were not taken. Funding operations of failing customers or more efficient co-creditors at the expense of one’s own income statement is generally hard to justify. It is important to keep in mind that, if the economy truly has entered prolonged stagnation or, worse, the second phase of a double-dip, many businesses will be financially stressed, having depleted their financial reserves during the first dip.
Time is always the enemy of collection. The average time taken to convert debt into cash received is measured by several key accounting and investment ratios for this reason, as is the percentage of all overdue debt collected. The first law of debt recovery is that time is of the essence: the sooner action is taken the better. Empirical evidence shows that, the older the delinquent debt, the less likely you are to recover it. Most senior executives, finance people, investors and bankers know that each day a debt is late erodes profit margins and available working capital. This removes the other valued uses to which the money could have been put if paid in accordance with the agreed terms. As the chart below shows, lax enforcement and delay greatly diminish the chances of recovery:
Of course, there is a balance between not deterring good customers and yet not financing the failing businesses of bad-credit risks. The answer is a blend of policy, procedure, communication and credibility. A reasonable credit policy clearly communicated to customers and enforced efficiently and evenly, can have a very significant impact on both profitability and on cash reserves. Where customers know and understand that payment terms are generally enforced, they will prioritize payments. It is when enforcement is unexpected or perceived as selective that customer relations suffer.
Effective credit and collection policy cannot be formulated in isolation: there is a balance between sales and credit needs. However, in an environment where sales are hard to come by, improving on the rate of conversion of accounts receivable into cash generally represents an effective, low-cost means to augment real revenue.
Steve Kailas, President, Kohner Mann & Kailas, S.C. firstname.lastname@example.org
Steve has devoted his career to upholding the interests of business creditors. As a litigator representing creditors and creditors’ committees in bankruptcy proceedings, he earned a reputation for exposing, litigating and reversing fraudulent transfers to recover for creditors. Steve has played a leading role in Wisconsin creditors’ rights law, and via legal persuasion, the law in other jurisdictions as well. Under his stewardship, Kohner Mann & Kailas was the dominant participant in the successful campaigns to avoid organized efforts to repeal the protection of the bulk sales law under the Uniform Commercial Code of Wisconsin. KMKSC also waged a successful six-year battle to reduce the time for litigants to render a commercial debt to judgment from 45 days to 20 days. Steve is a member of the Marquette University Law School Advisory Board and Chair of the Primerus International Society of Law Firms Liquidation of Commercial Debt Practice Group.
Stephen D. R. Taylor, Kohner Mann & Kailas, S.C. email@example.com
Prior to becoming an attorney with Kohner, Mann & Kailas, S.C., Stephen Taylor was a businessman and venture capitalist who focused on business strategy, primarily in the information technology field. He has personal experience of managing and delivering improved national and international accounts receivables collection performance in businesses in a number of industries. Mr. Taylor advises businesses on how to manage electronic information to protect their interests in the event of litigation, and on the conduct of electronic discovery. He also provides transactional and strategic support to businesses involved in trading across international and cultural boundaries and in identifying effective dispute resolution strategies arising out of such activities. An American attorney, Stephen also holds an MBA and Bachelor’s degrees in both International Trade and Politics & International Relations from British universities.
Kohner, Mann & Kailas, S.C. www.kmksc.com
Founded in 1937, KMKSC is a business and commercial law firm. KMKSC provides quality legal expertise across the areas of law encountered by businesses in the course of their operations and growth. Our services range from high-profile appellate representation and international business issues to ensuring that critical everyday needs, such as debt recovery, are fulfilled efficiently and expertly. Our purpose is to deliver excellent results for our clients, whether the issue is advice on the avoidance of legal disputes, closing a transaction, protecting assets or winning in court. KMKSC is continually advancing the interests of its clients in negotiations, transactions, litigation and alternative dispute forums across North American and beyond. We help U.S. companies address the legal issues raised by trading across international borders and provide legal support and advice to foreign companies operating in American markets.