April 21, 2022

	I. Is a Recession Coming?
	II. Grand Jury Indicts Former COO of Major St. Louis Construction Firm in Alleged Fraud Scheme

	III. Supply Chain Disruptions Are Changing the B2B Credit Profession
	IV. eNews Metric Series: Sales Weighted DSO Provides a More Accurate Picture of Collection Effectiveness

Businesses have heard chirps of a possible U.S. recession looming, but so far, much of the talk has been hot and cold. Some experts are certain the economy will decline within the next few years, while others say there are false red flags. However, most agree that companies should at least keep a close watch in the near term.

“The conditions don’t seem as dire as they were at the start of the Great Recession, but it is just so difficult to predict,” said David Beckel, CCE, who was NACM National chairman toward the end of the Great Recession in 2009. “As credit managers, that’s our job—to manage through these situations. Stay flexible but stay concerned about protecting your company’s largest asset.”

Moody’s Analytics and Goldman Sachs both predict the U.S. economy has a 35% chance of slipping into a recession within the next two years, and Deutsche Bank forecasts a recession sometime in the next three years. Fannie Mae expects a “modest” recession within the next year, but nothing as severe as the financial crisis in 2008.

Some traditional indicators of a recession have not appeared as strong as they were prior to the Great Recession. For example, the unemployment rate stood near 10% in 2009, but currently it sits at about 3.6%, according to the Bureau of Labor Statistics. “The recession during my time [as NACM chairman] saw unemployment rates going up, but we are seeing the opposite right now,” Beckel said. “It will be interesting if we go into a true recession because the job market is just so different today.”

However, other historical red flags surfaced with a vengeance in recent weeks. Consumer confidence is suffering, with more than half (63%) of Americans rating the national economy as “bad,” according to a recent CBS poll. And another historical recession indicator, the U.S. Treasury yield curve, inverted in late March, which has prefaced almost every economic recession.

Tightening monetary policy is another sign of financial stress. The Federal Reserve recently started raising interest rates, which could spell trouble if not done carefully, said Donald Burell, CCE, regional credit manager with Schlumberger Technology Corporation (Houston, TX). “The Fed has to get the interest rate perfect to avoid disaster, which has rarely happened,” he said. “If they go too far one way, we’ll see a recession. If they don’t go far enough, then inflation will continue to spiral out of control and eventually earnings won’t be able to keep up.”

What may be more concerning is the new factors weighing on the economy, including COVID lockdowns, the war in Ukraine and supply chain disruptions. “I’ve never experienced in this country the supply chain disruptions like we are seeing today,” Burell said. “That along with the inflation rate are the biggest concerns I have as a credit manager because in my opinion, it is extremely artificial and created by a lot of cash being printed and dumped into the U.S. economy. Eventually, that’s going to catch up with us and there has to be an adjustment.”

Certain industries are struggling with inflation and supply snags more than others. Kim Hanlin, credit manager with Kloeckner Metals Corporation (Dallas, TX), is already starting to see some signs of customer distress. “Steel prices have gone through the roof,” she said. “We see customers already struggling to pay, even customers that have always paid on time are now asking for extended terms.”

Slowing sales is another early indicator for creditors that the economy is struggling, especially following robust economic activity like many have seen for the last year, said Norman Cowie, CCE, director of credit at Paramont-EO, Inc. (Woodridge, IL). “When I go back to the Great Recession in 2008, the first thing we noticed was sales starting to dry up,” he said. “I can see the buildup the same way it was before, but it’s not being built on the same house of cards. I don’t think [the Great Recession] can be replicated but I do think a recession could happen for other reasons.”

Cowie, like so many others, is waiting for the other shoe to drop. “We had record sales last year and zero bad debt for the entire year, but that scares me a bit because I’m wondering when the crash is going to follow,” he said. “When you have the economy going very quickly like it is right now, you have to think about what is the thing that could get the economy off track. There are many factors now that could do just that. Maybe supply chains will be the housing market of ‘08, who knows?”

Keep an eye out for next week’s eNews article to learn about best credit practices for before, during and after a recession. To learn more about where the economy is headed, be sure to attend the educational session: An Economic Update: What Can We Expect? during NACM’s 126^th Credit Congress from June 5-8 in Louisville, KY.

The federal grand jury recently indicted Brian Kowert, Sr., former chief operating officer of HBD Construction Company, for five counts of wire fraud related to falsifying the company’s participation with a minority business enterprise (MBE) on several construction and redevelopment projects from 2014 through 2022, according to the U.S. Department of Justice.

Kowert, Sr. also served as owner, executive vice president and a project manager on projects in St. Louis and the Midwest. The indictment alleges that Kowert, Sr., defrauded St. Louis and Missouri governments as well as several clients by falsifying records to inflate MBE participation, which was required on those projects.

The indictment alleges that Kowert, Sr., used actual MBE certified companies as “front” companies to pass payments to non-MBE certified companies, which performed work on the project. “The MBE certified companies neither performed work nor provided materials on the projects and had no actual contact with the non-MBE companies which actually performed the work and provided the materials,” according to a Grand Jury press release. “The MBE certified companies were paid a nominal fee by Kowert, Sr., for acting as a ‘pass through’ for the funds paid to the non-MBE companies.”

The indictment further alleges that he provided false reports on three separate projects located in St. Louis and Kansas City metropolitan areas and that the client companies, city and state had no knowledge of the alleged criminal activity. The reports accounted for hundreds of thousands of dollars of work. Charges set forth in the indictment are merely accusations and do not constitute proof of guilt. 

Most public procurement contracts have participation goals or requirements for disadvantaged groups. Under the U.S. Department of Transportation (DOT), which has the most comprehensive requirements, and some other agencies, the disadvantaged contractor must perform a commercially useful function (CUF) that helps participants develop into financially strong contractors.

It cannot be an extra participant in a transaction, contract or project, through which funds are passed in order to obtain the appearance of disadvantaged business enterprise (DBE) participation. The contractor must perform, manage and supervise the work. For example, with respect to materials, the contractor must (a) negotiate price; (b) determine quality and quantity; (c) order and install the material, where applicable; and (d) pay for the material—the four pillars or touchstones of these projects.

“To participate in these lucrative projects, some contractors have knowingly engaged in DBE fraud to meet the project’s DBE requirements, diverting all of the profits to their non-DBE businesses,” according to an article by Cohen Seglias Pallas Greenhall & Furman P.C., Passing on the Pass-Through: How to Avoid DBE Fraud Through Due Diligence. “DBE fraud generally takes on one of two forms: a ‘front’ company or a ‘pass-through’ company. In the front company scheme, a non-DBE firm creates a DBE company as a front to bid on projects, while ultimately diverting all of the work (and profits) to the non-DBE contractor. In the pass-through company scheme, a legitimate DBE acts as an intermediary, passing the majority of the work on to a non-DBE firm while invoicing the general contractor for the non-DBE’s work, plus a small percentage fee (payable to the DBE firm, usually around 3%).” 

A variety of programs exist, including minority business enterprises (MBEs), small minority business enterprises (SBEs) or DBEs. Each comes with its own requirements and rules. Having an entity that performs the four pillars, however, does not guarantee a “safe harbor” from violations. On some projects, the disadvantaged business must perform or exercise responsibility for a certain percentage of the contract value. Otherwise, there is a presumption that it did not perform a commercially useful role.

The pandemic shocked the global supply chain roughly two years ago, and it has not been able to fully recover since. While there has been some speculation about best solutions, no one has come up with a solid answer to today’s most pressing question: How do we fix the supply chain for good?

“This has dragged on long enough now that on the supply chain side of my job, we are all talking about how this may just be normal and we may never be able take the supply chain for granted again,” said Shaun Papperman, CCE, CCRA, CICP, director of order fulfillment at Baltimore Aircoil Company, Inc. (Jessup, MD).

Each incident on its own might have created only minor disruptions, but once you combine the war in Ukraine, Covid lockdowns, trucker shortages, logistics issues and booming demand, “it sends bigger and bigger shockwaves through the supply chains,” Papperman said. “You’ve got this death by a thousand cuts happening.” 

Supply chain disruptions have only gotten worse, and they are starting to change the job of the B2B credit department structurally. Roughly 65% of credit professionals are extending more credit as a result of the supply chain crisis compared to 45% last April, according to a recent eNews poll.

This time last year, only 16% of respondents struggled with stuck orders and 34% reported more orders in transit compared to more than half (53%) who are seeing both today. Shipping times for products are still taking longer than normal, with 41% experiencing increased turnaround times compared to 46% previously.

“We are seeing an increase in overall port congestion,” said an NACM member. “We are struggling to get vessels; and when we do, it is a couple weeks to a couple months late. We’ve had orders expected to go out on a certain date that get pushed out 30-plus days, which ultimately impacts the terms we are offering and cash forecasting because we can’t expect [customers] to pay according to their original terms when they are not getting these orders on time.”

And late orders lead to more disputes. According to the poll, 41% of credit professionals are dealing with more disputes than before the supply chain chaos started. That may partially be due to how supply disruptions “create a much more combative environment,” Papperman explained.

Larger retailers are sometimes quicker to dispute an order, which can cause a loss in revenue, said Faith Padgett, CICP, credit manager with Farm Direct Supply LLC (Fort Lauderdale, FL). “We are actually prioritizing who gets what because some customers will charge us if the product does not get there,” she said. “So, those customers will get their product first and that might mean another customer does not get their product on time. In that case, we will try to buy product to prevent that from happening and sometimes we lose money just to make sure we fulfill their orders.” 

All this translates into more hurdles for the credit department and less time for team members to focus on other tasks. “Supply chain disruptions have made my job much harder,” Padgett said. “I am seeing more receiving discrepancies, which all take time to sort out. I only have so many hours in the day, so these claims take time away from my normal day-to-day collections.”

Businesses and credit departments both need to find ways to adapt because supply chain disruptions are here to stay, Papperman said. “The companies that are more flexible have had greater success navigating these disruptions. If you haven’t learned to be flexible and think outside of the box, you won’t survive this.”

You cannot necessarily control supply chain disruptions from an external standpoint, but you can do your best to mitigate the impact internally, an NACM member added. “We are doing everything we can to be a dynamic business and switch gears to deal with these issues. We are trying to find if we can bring in new vendors to alleviate our supply disruptions, and we have seen improvement internally. But externally, things look like they are getting worse.”

Each company should consider what options are best. For example, it might make sense in one company to further diversify its vendor base, but nearshoring may work better for others, Papperman said. “The solution is really going to end up being a hybrid approach.”

If you want to learn more about how to navigate supply chain disruptions in the credit department, be sure to attend Papperman’s educational session: Effectively Communicating Your Supply-Chain Status: Fulfillment, Pricing and Contract Modifications, and Other Related Issues at the 126^th annual Credit Congress from June 5-8 in Louisville, KY.

The sales weighted DSO metric provides a more accurate way to measure a credit department’s collection effectiveness because it removes the impact payment terms and sales have on some days sales outstanding formulas. One way this is done is by dividing the aged receivables for each month by the comparable sales figures for each of the aging brackets multiplied by 30.

“[Sales weighted DSO] uses sales like other DSO calculations, but it also uses specific aging buckets within the calculation, which makes it unique,” said Edward Olewnik, CCE, senior manager of credit services for CertainTeed (Malvern, PA). For example, instead of calculating DSO based on averages derived from the total sum of outstanding accounts, it is calculated using averages derived from specific outstanding accounts in 30-, 60- or 90-day aging buckets. It is otherwise similar to standard DSO.

Many credit teams use DSO calculations as a KPI to measure against the gap between payment terms and the amount of days the AR is outstanding to show trends of improvement or decline over a period of time, Olewnik said.

Removing bias from metric calculations is important because a credit department’s portfolio may contain a variety of accounts with differing face values and payment terms. “[Sales weighted DSO] likely smooths out sales and [payment] terms of the sales, when there is an account with higher terms or a wide variety of terms, or both, within the portfolio,” Olewnik said.

However, these calculations may potentially cause more work for credit professionals looking to gain an accurate measurement. For example, creditors may have to compute a weighted terms of sale to establish a benchmark to determine if their sales weighted DSO number is good or not, Olewnik said. Furthermore, if few companies use sales weighted DSO, it may be hard to establish a baseline.

“Different industries have different DSO [calculations], so it is difficult to compare between companies or have a set benchmark if your clients are from different industries,” said Isabel Perez, CCE, CICP, vice president of credit risk and audit coordinator of Latin American Agribusiness Development Corporation (Coral Gables, FL). “In our case, we use it to see if there are collection issues from one year to the next on the same client.”