April 14, 2022

	I. Avoid Misleading AR Measurements
	II. The Risks of Selling to Unlicensed Contractors

	III. eNews Metrics Series: Average Days Delinquent
	IV. Resources You Can Use to Verify Customers in Mexico

Accounts receivable (AR) is as vital to a business as oil is to a well-run vehicle. Mismanaged AR can lead to cash flow shortages and easily create trouble for a company. On its own, AR shows the total credit sales that are yet to be paid. But it also is used to calculate days sales outstanding (DSO) and learn customer payment patterns.

AR is not a formula, but rather a sum of all money that is owed by customers. It is up to you and your company to decide which data points are best to include in that sum for your particular business.

“Data used for metrics will be driven by policies, company philosophies and strategies; particularly when it comes to unapplied cash, advance payments, disputes, deductions and if systems have the ability to manage accounts in a suspense or notes receivable ledger,” said JoAnn Malz, CCE, ICCE, credit and collection manager with Danfoss Power Solutions II, LLC (Eden Prairie, MN).

According to a recent eNews poll, many credit professionals use similar data points in their calculations for accounts receivable. The most common are credit balances (92%), deductions (88%) and disputed invoices and advance payments (71% each). Accounts in collection are used by creditors the least often (58%) for total AR.

Businesses may include or exclude certain data from their total AR for a variety of reasons. “Some accounting software has limitations or it’s just how they’ve always done it,” said Charles Edwards, Jr., CCE, director of credit operations with SRS Distribution (Herndon, VA). “About 80% of the time, it is a direct reflection of accounting policies driven outside of credit.”

Removing some data from your total AR calculations also could be a way to get a more accurate collectable amount. “For example, if bad debt is managed in the same place as all of your active and healthy AR, the amount of dead AR will keep growing and would make it look like the credit team was performing worse and worse over time,” Edwards said. “Not because of anything you are doing wrong, but simply because the accounting process does not remove dead AR from the total AR.”

Outliers of any kind will drastically alter AR over time and could make it appear as if the credit department is performing better or worse than it actually is. “Removing certain data allows you to avoid false narratives behind the metrics,” Edwards said.

Look at today’s supply chain crisis as an example. If you are in an industry where your products now have longer lead times than before, you likely have more deposits in your AR. "It is not uncommon for a product that used to have a two-week lead time to now have as much as an eight-week lead time,” Edwards said. “So now that you are carrying your orders for a longer period of time, you could be carrying as much as four times the deposits, and those really large balances are driving your AR down.”

That ultimately means your collection percentage will improve and DSO will be reduced, sending a false message that your collection effort has improved when in reality, that number is artificially inflated. “If you compare your AR today, which is carrying eight weeks’ worth of deposits, to March of last year when you were only carrying two weeks’ worth, that difference is significant and meaningful,” he said. “It is so important in data analytics that you make sure you are comparing things that are truly comparable.”

Accounts receivable, just like other metrics, “helps us realize whether there is a red flag or not,” said Juanita Reyes, credit manager with Eastern Quality Foods (Ponte Vedra Beach, FL). “It can help indicate if we are seeing a change in payment behavior, so it is vital to have those figures at your fingertips because that data tells a story about your customers.”

What happens if you find yourself working with an unlicensed contractor? Or your customer’s customer—perhaps, the general contractor—is unlicensed? Understanding the risks beforehand and the steps for mitigating them will help you avoid unnecessary headaches.

Even if your company has contracted with a licensed party in the supply chain, are you sure about upper-tier contractors? If your company’s customer does not receive payment from the unlicensed general contractor, for example, how could this impact your company’s ability to get paid for supplies it has provided?

Performing work as an unlicensed general contractor is often illegal when the cost of a job exceeds a certain amount specified in individual state statutes. An unlicensed contractor likely won’t volunteer whether it lacks the proper documentation required by the governing state law. It is up to you and your company to determine whether a contractor is properly licensed.

Why It Matters

Licensing protects not just the public, but also the contractor and the parties with which it works. Licensing involves passing exams and meeting certain criteria to demonstrate reasonable competency in a trade. There is no oversight for contractors without licenses, which means there are fewer legal remedies if something goes wrong.

“We call it the death penalty for contractors when they are unlicensed [because] the contract is of an illegal nature,” meaning it is unauthorized or unlawful, said Christopher Ng, managing partner at Gibbs Giden Locher Turner Senet & Wittbrodt (Los Angeles). In most cases, the unlicensed contractor has no protections under the law—even if the owner knew the contractor was unlicensed. However, “It is a violation of the law for a contractor to hire an unlicensed subcontractor,” he added. “That may lead to disciplinary action by the Contractor’s State License Board, resulting in civil and even potentially criminal penalties.”

An unlicensed contractor that falls anywhere within the tier of suppliers and contractors could disrupt an entire project—putting lien rights in jeopardy. Typically, unlicensed contractors do not have lien rights, and contractors that do not have lien rights lose their ability to put pressure on the project owner for payment, which means material suppliers and subcontractors could go unpaid, said Chris Ring, of NACM’s Secured Transaction Services (STS). In some states such as Washington, the loss of lien rights carries down to the material supplier.

However, a loss of lien rights could extend to your company, depending on how courts view it. A savvy attorney, owner, lender or general contractor might convince a court that you are a supplier to another supplier because an unlicensed contractor could be viewed as a distributor, Ng said. In some states such as California, a supplier to a supplier does not have lien rights.

“You should always confirm that the contractor is licensed,” Ring said. “Washington is the only state where if you sell to an unlicensed contractor, you also lose your lien rights.” In other states, suppliers can still exercise lien rights within statutory guidelines regardless of the contractor being unlicensed. Ring stressed being mindful of the supplier-to-supplier scenario mentioned by Ng because that could apply in any state.

And without proper licensing and workers’ compensation coverage, a contractor is more likely to be insolvent or go bankrupt if an accident occurs or an unexpected issue arises. For example, “If you sell supplies to an unlicensed contractor for an installation that involves security measures such as a fire alarm or security system, the liability from that system’s failure could carry down to you,” Ng said. “Conversely, if you sell supplies to a licensed contractor and the same issue occurs, you may be protected due to the contractor’s liability insurance coverage.”

Cover Your Bases

It is not always easy to determine whether a contracting entity is licensed or not. A company may list a sole proprietor or individual officer who is a licensed contractor, but the company itself might not be. Verify that the name on the credit application for the contractor you provide goods matches the licensed entity, Ng advised. “And vet the license number and name on the Contractor’s State License Board website.”

In some cases, suppliers may want to ask for a copy of the agreement between its customer and the general contractor or owner to ensure the subcontractor has agreed to perform work on the construction project, Ng said. If there is push back, ask them for a redacted copy.

“You don't need to see the contract price or some of the more sensitive information, but you do want to make sure you are covered under state mechanic's lien laws,” Ng said. If you already supplied the material and found out the contractor was unlicensed afterwards, ask your customer for written assurances that seek to rectify the issue, he continued. For example, “Because you don’t want to be accused of pulling the rug out from underneath your customer, I would send a notice under 2609 of the California Commercial Code, which may allow you to suspend performance of your obligations until you get adequate assurances of performance (i.e., payment) from those upstream.” Check state commercial codes for the areas in which you do business.

“In most states, licensed contractors that do not maintain proper workers’ compensation coverage or utilize a proper qualifier may be considered unlicensed,” according to Ng. Moreover, a contractor’s failure to post a surety bond may render it unlicensed. In California, contractors must post a surety bond of $15,000, soon to be $25,000, to do business, Ng said. The state licensing board overseas all administrative regulation of contractors and ensures contractors are performing work they are qualified for depending on the class of their license.

To learn more about licensing laws in the state of California, be sure to register for Ng’s presentation during NACM’s upcoming webinar, How California’s Contractor Licensing Laws Impact Distributors and Suppliers, at 3 pm ET on April 18.

Average days delinquent (ADD), also known as delinquent days sales outstanding, tells the credit department the average amount of time it takes for late payments to get collected and converted into cash. Take your standard DSO and subtract best possible DSO, and you get your ADD. If your department’s ADD is high, it means customers are taking longer to pay and may require more proactive collections efforts. A low ADD means you are collecting cash from your customers quickly.

As with any metric, ADD has strengths and weaknesses. ADD is great for helping the credit team predict default rates, project cash flow and improve communication with customers, said Darrell Horton, ICCE, director of credit at Litigation Services, LLC (Las Vegas, NV) and NACM chairman.

“Average days delinquent is a good barometer of where we are at; because let’s face it, the credit and collection team generally work on past due invoices,” Horton added. “As quickly as we make the sale, we want the cash back in our pockets so we can do something else with it, and ADD can help make sure we are doing just that.”

However, it is important to note that the metric has some blind spots. ADD only measures late payments for right now, not over a long period of time. Because the metric’s formula hinges heavily on DSO, it is subject to drastic swings, said Tyler Steenblik, CCE, regional credit manager with Young Electric Sign Company (Salt Lake City, UT).

“A company’s revenue figure can make DSO fluctuate constantly, so that portion of the calculation makes it difficult to measure collection efforts,” he said. “When you’re dealing with DSO and BPDSO to get to ADD, every time you bring another part into it, it levels out that metric and helps normalize the wild swings. But in my mind, it is still a problem because revenue will either help or hurt DSO even though collections has not changed a bit.”

Steenblik’s department still calculates ADD, but makes sure to compare it to other metrics. “In our company, we don’t focus on one metric. A lot of times we find ourselves tracking eight different metrics over a period of time.”

ADD is typically measured against standard DSO, and both should almost always trend in the same direction. If you see a high DSO and low ADD or vice versa, it likely means there has been a change in credit terms or AR cycle rather than an efficient or inefficient credit department. That’s because changes to AR can affect DSO without affecting your ADD number. “For example, a really good sales month or a really bad sales month can cause both metrics to go in opposite directions,” Steenblik explained.

The correct resources can provide key information you should consider when evaluating and selling to prospective buyers in Mexico on trade credit, so that you can build a strong due diligence strategy.

“It is possible to get reliable information in Mexico in a cost-effective way to gain a business advantage—whether to evaluate and eliminate risk or to assess litigation,” said Romelio Hernandez, president at HMH Legal, during FCIB’s recent webinar, Trade Credit in Mexico: Investigating Customers and Debtors - Part 1.

A group of companies operating under the same owner should serve as a red flag, Hernandez said. In these types of instances, ask for guarantees from shareholders, the controlling corporation or other corporations in that group, he continued.

Hernandez recommends using a credit application as a first line of defense. Consider including questions such as:

• Does the prospect have any lawsuits against it?
• How many corporations operate from the same address?
• Is the prospective customer part of a corporate group?
• Who is its customs broker in Mexico?
• How many years has the company been in business and what is its brand presence?

Finding the company’s customs broker allows you to summon them to court to testify if they imported products on behalf of your customer, Hernandez explained. Asking how established a company is can help you determine how easily the business could close shop and open elsewhere—allowing them to transfer assets easily.

Ask your prospective customer to include a copy of its credit report with its application. The Mexican Credit Bureau will not share information directly with third parties; it only shares information with other creditors or buyers that enter into a contract with the bureau and then provide information on a monthly basis. “But the good thing is that everyone in Mexico will have credit history with the Mexican Credit Bureau. Companies and individuals can ask for two free reports a year.”

Hernandez also recommended reviewing certain indexes that rate the performance of Mexican courts. The risk of enforcing a contract will be lower in places where courts perform better, he pointed out. “So, you should check where your customer is from because these are places where it’s probably a little bit safer to conduct business, where you have a strong rule of law and where you have less violence.”

Some free resources that provide valuable information include:

• RUG—registry for security interests and loans (www.rug.gob.mx)
• SIGER—nationwide corporate records for companies in Mexico (rpc.economia.gob.mx)
• IMPI—records of trademarks and patents (marcanet.impi.gob.mx)

The RUG system allows creditors to view if the company has any loans from banks or if any liens have been filed against it, Hernandez said. However, to create a user on the RUG system, you need a Mexican tax ID. To obtain one, seek help either from a sales rep or another source in Mexico that has an ID that can help you create one.

The SIGER platform is almost the same as the RUG system, Hernandez said. It does provide additional information by displaying who incorporated the company, who the shareholders are, representatives, changes in the company, available shares, etc. “About 80 to 90% of information on Mexican companies will be here.”

IMPI can be useful as it shows if the customer has registered trademarks or patents, he said. This indicates the customer has a strong brand presence.

Two other services creditors can access refer to nationwide lawsuits and public registry investigation, Hernandez said. Accessing nationwide lawsuits is a private service, but many service providers in Mexico can give that information to you. If you see the customer is a defendant in many cases, it means they are being sued, which can be a red flag.

Investigation through the local public registry allows you to view customer information on liens, corporate information, assets, loans, bankruptcy and liquidation, Hernandez said. However, it can be pricey and time consuming depending on the registry.

The final two resources you can access are SIEM and SOIA. SIEM is another database that shows company information for those that are registered in the local chambers of commerce. SOIA shows if a customer has an importing license and who they are importing from.

As a final measure to ensure your customer is legitimate, do a physical inspection, Hernandez said. For example, verify the company’s situation as stated in the credit application by researching its employees, inventory, facility size, neighborhood etc. “You can do this through a local sales rep or source. If you don’t have a local source, google the company and do a virtual walkthrough.”

To learn more about how to do business in Mexico, be sure to register for the next section of Hernandez’s presentation during FCIB’s Trade Credit in Mexico: Securing Trade Credit - Part 2 webinar on May 10 at 11 am EST.