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Credit and Collections:
Part One

Money is a poor man's credit card.1

ne of the toughest questions for every business — large and small — is whether and how to extend credit. Simplistically, the "cash and carry" business has always had much to commend it. The entire transaction is completed at the point-of-sale (POS).

          However, the extension of credit has been an important marketing tool since the earliest days of commerce. The extension of credit for small-value purchases is often simply a matter of convenience for many customers precluding the need to carry large sums of cash. It can also enhance customer loyalty. And the psychological phenomenon is well understood that human beings tend to spend more freely when they are not required to lay cold cash on the counter. Particularly impulse sales increase significantly when hassle-free credit is available. The emerging department stores in the Nineteenth Century grasped these behavior patterns by offering "charge accounts" to their preferred customers; various deferred payment arrangements were also common among neighborhood grocery stores and other community enterprises.

          But the extension of credit is frequently a mandatory marketing tool for high-value sales, especially for capital assets. The provision of "auto loans" far surpassed any of the technological advances of the 1920s in establishing a mass market for the automobile. Financing is commonly the critical component in closing the sale for many engineering/construction projects — from modest home renovations and remodeling to large electric power generation facilities almost any place in the world. The availability and terms of credit are often much more important than the basic price and even performance specifications of the product/service being sold. For many transactions, the cost of financing is the most important expense (line item) for the asset. (This is an economics lesson understood by almost every home owner.) The availability and cost of credit is now recognized to be the most material single influence on the health (growth or stagnation) of the national economy — hence, the critical role of monetary policy defined through the discount rate set by the Federal Open Market Committee (FOMC) of the Federal Reserve System, the baseline for all other public and commercial interest rates.  While obvious, the harsh reality should never be suppressed that most credit sales spring from the customer's lack of or at least unwillingness to part with the money to meet the asking price of the transaction at this time. Therefore, all "credit analysis" can be simply reduced to the question, "Will the customer be able and willing to meet the schedule of payments in the future in conformance with the credit agreement?" Several now-sophisticated industries have arisen to help answer this question.

          Today, the counsel to the owner/managers of virtually all emerging businesses is, if at all possible, "Don't get into the credit business; let the experts handle it for you." Credit provision and management has become a complex and competitive business. The credit card has revolutionized retail credit. The ubiquitous credit card, including charge cards, debit cards and bank cards, now makes it unnecessary — indeed foolish — for most retailers to offer their own credit. While a few merchants still balk at the accompanying service and transaction fees, these costs are indeed minor in contrast with the direct and indirect credit costs that would otherwise be incurred by the smaller merchant. And these credit card costs are now factored into the price of nearly all retail transactions.

          The startling-high credit limits now being extended to many credit card holders enables them to also be used for some higher-value purchases. However, these businesses customarily want to arrange a credit relationship for their customers with a bank or a commercial finance company. This was chapter one in the book on auto-financing written by the automobile dealers in the 1920s. Financial institutions are eager to develop this kind of business, and are very competitive; this enables the smaller business to offer superior financing to its customers, but not to become entangled in the credit business itself.

          Finally, asset-based or secured lending has now become a mature source of credit. Known until the last few decades as factoring and once a slightly-disreputable business, accounts receivable are sold without recourse to either a bank or a commercial finance company. Again, the financial institution undertakes all credit investigations, provides all funds, and assumes total responsibility for collections. The emerging business does not become entangled in the credit business.

If at all possible, don't get into the credit business; let the experts handle it for you.

1 Marshall MacLuhan, Maclean's, June 1971.

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