This article originally appeared in the May/June 2020 issue of NACD Directorship magazine.
Years ago, one of us approached a board member of a large company and asked, “What would you do if your firm had a serious issue with credit and related collections?” He pondered this for a moment and said, “Resign. This is a core management issue and the board cannot fix it”
Unfortunately, many companies are likely to encounter credit problems during the COVID-19 pandemic and will have little choice but to work through them. With entire industries reeling, some companies will have to deal with customers and suppliers that are struggling. Banks are the first and foremost credit providers, but credit is an essential part of the “offer” that many businesses, including manufacturers and dealers that augment sales with purchase financing, provide. Even commercial real estate can be considered a form of credit.
The collapse in business demand emerged quickly once lockdowns and stay- at-home orders were put in place, and firms have generally focused on operational continuity. But this wave of change is bringing different issues than have been apparent in other crises. How should businesses man- age credit policies, which need to balance their role in sales, service to customers, and cash flow? Restrict credit and customers may flee; forgive too much and the firm could be overextended.
We believe that prior experience will be a poor guide, as the processes that normally drive credit decisions are unlikely to be successful in this unprecedented situation. Trusted processes and data sources may not adequately protect the company. For businesses that are reliant on collateral or liens, the prospect of dealing with a large number of distressed assets may be daunting.
What will your firm do if receivables or credit are systemically not paid? What should the role of the board be?
Boards must ask the right questions to ensure credit-related challenges are understood and that management is proactive in identifying and mitigating issues. Credit is not a common topic for boards, but given the speed of this crisis, concerns about firm liquidity, and the need to support customers and suppliers, it should be included on any COVID-19 response agenda.
Boards can start by focusing on three key issues.
1. Customers. Customers remember those who treat them well. This drives simple questions with hard answers: What is the optimal way to segment our customers? What is a customer’s financial condition and future potential? What risks can we take, and not take?
2. Infrastructure and processes. It is necessary to update credit processes to yield long-term results beyond the current crisis. How can we continually enhance credit processes as client circumstances change? How can we ensure that we learn and in- corporate what we learn into our practices?
3. Financial results. Management and the board need accurate forecasts of financial results. This is a devilishly hard problem during the current crisis. What can be done to improve accuracy and information about the value of credit granted before and in the future in the face of uncertainty?
Choices surrounding credit will vary based on industry, product, client needs, risk tolerance, and expectations for the economy. These choices are complex and will likely vary over time, and process change will not come easily. For many, credit will be important enough that a “credit control tower” coordinating a firm-wide response is appropriate. The “tower” needs to take an enterprise view that links sales to financial forecasts to liquidity, utilizes external insights, and translates this to specific policies and decisions. It is the board’s role to evaluate the situation and ensure such a capability is created if needed.
Focusing on credit issues is not without an upside, since assisting customers and suppliers that need temporary support can significantly improve long-term loyalty. The board can play an important role in ensuring that trade-offs between short- and long-term outcomes are well-thought through and well-founded.