January 26, 2023

As the uphill battle against inflation continues, speculation has been swirling around whether or not the U.S. will be able to avoid a recession. The Federal Reserve would need to pull off a soft landing—which is rare but not impossible. The last time the Fed was able to curb inflation without driving the economy into a recession was in 1994.

In a series of seven rate hikes beginning in February 1994 and ending one year later, policymakers doubled interest rates to 6%. “The result was successful,” reads an article from Vox. “The economy averted a recession, inflation stabilized around 3% before drifting down and unemployment continued to fall for most of the late 1990s. Although economic growth weakened in the first half of 1995, it later rebounded, and a period of strong expansion followed.”

But the situation today does not look as promising. Despite the fact that inflation has eased in recent months and the unemployment rate remains low, economists put the probability of a recession in the next year at 61%—up from 18% at the start of 2022, according to a Wall Street Journal survey. The pandemic, the war in Ukraine and supply chain challenges are just a few factors making it much more difficult for the Fed to pull off a successful soft landing. “Very few think we can avoid a recession altogether,” said NACM Economist Amy Crews Cutts, Ph.D., CBE. “Although the baseline estimate is that it will be a rather mild recession.”

Prices for some goods have fallen but others remain at historically high levels—like eggs and corn. “I see a lot of signs here that point to a weakening in the economy that may feel recessionary to a lot of households,” Cutts added.

Still, experts who see the possibility of a soft landing in the future exist. “The possibility of getting a soft landing is greater than the market believes,” Jason Draho, an economist and the head of Americas asset allocation for UBS Global Wealth Management, told The New York Times.

It also is possible that economic recovery will end up somewhere in between a soft landing and a recession—known as a K-shaped recovery—where one portion of the economy begins to climb back while the other suffers. “Another potential factor for a K-shaped landing could be the growing pressure on small businesses, which have less wiggle room than bigger companies in managing costs,” reads an article from The New York Times. “Small employers are also more likely to be affected by the tightening of credit as lenders become far pickier and pricier than just a year ago.”

The Fed is expected to continue raising interest rates this year, although at a less aggressive pace. Cutts does not expect the Fed to actually cut rates until 2024. “The Fed is likely to overestimate where inflation actually stands because the Consumer Price Index is a lagging indicator, meaning by the time the numbers are released it is already old data,” she added.

NACM’s Credit Managers’ Index (CMI) shows that credit professionals sense trouble ahead as sales have dopped roughly 20 points year-over-year and more customers are paying beyond terms. “The Index came down from very high levels earlier in the year and it’s registering on the verge of recession,” Cutts said. “That means that businesses are already feeling the tightness in the market.”

Interest rates have been top of mind this past year. The Federal Reserve raised rates a total of seven times in 2022 bringing its target rate to a range of 4.25% and 4.5%, the highest in 15 years. The Fed is expected to continue with its rate hikes well into 2023. “I actually think rates are probably going to go higher than 5% ... because I think there’s a lot of underlying inflation, which won’t go away so quick,” JPMorgan Chase CEO Jamie Dimon said during the World Economic Forum in Davos, Switzerland.

Carrying receivables for longer periods of time in a high interest rate environment is expensive, making timely collection even more crucial. “Customers are now less willing to spend and less likely to pay on time than ever before,” said George Schnupp, CCE, director of global AR operations at Anixter, Inc. (Glenview, IL). “As the interest rate hikes continue, companies will experience further declines in operating margins, thus retaining less back into their equity or owner’s financing. This, in turn, impacts the terms and conditions and collection pricing that creditors provide for their customer.”

Monitoring interest rates has become important for both collections and credit risk assessment. By doing this, credit managers can see if payment terms are lengthening or shortening while monitoring collections. “Today, our customers engage in spontaneous financing, where we become their bank and they hold on to their cash,” Schnupp said. “It is important to monitor DSO and the Best Possible Days to Pay versus Average Days to Pay with the difference representing the Average Days Delinquent.”

As credit professionals, we need to be able to measure the cost of missed payments and explain that to upper management. “I’ve received more requests to extend terms on certain projects or large purchase orders,” explained Yazmin Yepez, CBF, CCRA, CICP, credit supervisor at Mitsubishi Electric Automation, Inc. (Vernon Hills, IL). In such cases, customers request payment term extensions so they don’t have to finance the cost of the items that were already shipped.

Mark Zavras, CICP, director of credit at Sub-Zero Group, Inc. (Scottsdale, AZ) says he is seeing more customers struggling to pay on time. “Some customers in our mid- and rural markets are asking for split terms where customers are paying half of the balance one week and the other half the following week,” Zavras said. “This occurs at year-end because they have more inventory and supply chain challenges, which affects their liquidity and they start borrowing money.”

Once customers start going beyond terms it can be difficult to reverse the trend, so credit professionals should be as proactive as possible. “I would like to encourage credit managers to be vigilant and identify the red flags when customers ask for payment term extensions,” Yepez said. “We want to support our customers but at the same time we can’t be expected to finance balances that they refuse to finance through a line of credit that will incur interest and fees.”

An alumnus of NACM’s Graduate School of Credit & Financial Management, George Schnupp, CCE, is the instructor of NACM’s Financial Statement Analysis 2: Credit and Risk Assessment course. Learn more about the course, which is offered at NACM’s Credit Congress and during a one week program in Columbia, Maryland.

Those in the construction industry will need to stay vigilant in 2023 as the economy continues to change. Builders are most concerned about project delays due to supply snags (63%), a lack of skilled labor (70%), an economic slowdown (74%), rising material costs (73%) and high interest rates (67%), according to a survey from Associated General Contractors of America (AGC).

“There are always challenges that surround the construction industry because it is by nature a very risky environment,” said Chris Ring of NACM’s Secured Transaction Services. “That’s why there are mechanic’s liens and bond claims to protect people selling in the construction industry.”

Lack of Skilled Labor

An aging workforce means there will be difficulty hiring replacement staff with the experience and expertise needed for different roles. Without a formal business plan left in place for the next person, it will be hard for the business to be sustainable. “There are a lot of people in the workforce coming up on retirement age, so when someone retires from a business who’s been running it for years, the new person needs to know how the business will keep functioning,” Ring said.

When taking a chance on potential staff, employers can invest ample amount of training and time for an employee who may quit and leave to go somewhere else. A certain skillset is required of contractors in the construction industry that make positions especially difficult to fill.

“Hiring has been a big problem in the last year,” said Jerry Drake, CCE, director of credit and collections at Apogee Services (Owatonna, MN). “It has been hard for project owners to find skilled contractors who know how to install material correctly. If the material gets broken during installment, the issue can trickle upward to the material supplier.”

Recession

An economic slowdown or recession creates a wide net of challenges for everyone—but in the construction industry, it can dry up new projects and leave contractors scrambling to find work. Construction is often one of the first industries to feel the pressure of an economic downturn. Some economists expect the construction industry to fall into a recession as early as this summer.

“We as collections specialists are under more pressure now to keep payments coming in on time,” Drake explained. “We are placing accounts on hold as they go past due quicker than we have in the past in case the economy goes into a full-blown recession, and we certainly don’t want to give up lien and bond claim rights because those are our parachute for protection in the event that we can’t get paid.”

With a recession is likely to come a major uptick in corporate bankruptcies. “Make sure you’re working with your bank and have access to cash in order to keep your projects going in case the job hasn’t funded you yet,” said Isaac Kotila, credit support manager at Insulation Distributors, Inc. (Chanhassen, MN).

Material Costs

Inflation is another setback for the industry, as the cost of needed materials has spiked. And in turn, laborers and project managers for example, may need higher credit lines to purchase the same amount of product. Builders will need to be able to pass on those rising costs to their customers in order to properly pay the material suppliers.

“From the perspective of a material supplier, rising material costs are going to be a struggle for many companies,” said Kotila. “The rise in inflation costs and interest costs around the debt that they’re taking puts a big stress on a lot of those companies, especially in scenarios where they’re having trouble getting payments from one of their customers. We see issues with material costs increasing and the customer’s overhead is getting higher based on the way the market is, but they’re not passing that along to their customers.”

Project Delays Due to Supply Chain

Supply chain backlogs will only continue to cause project delays in 2023. 70% of builders accelerated purchases after winning contracts and roughly half looked for alternative suppliers or materials to cope with supply shortages in 2022, according to AGC.

“Supply chain issues and material cost issues will continue, and will continue to have profound effects on schedules and affordability of new projects,” said Mac Caddell, president of Caddell Construction headquartered in Montgomery, AL, during an AGC webinar.

Want to learn more about the construction industry and network with other construction credit professionals? Join our Construction Credit Thought Leaders for monthly discussions on related topics.

The pandemic acted as a catalyst for businesses to incorporate more technology and automation in every day processes. Many companies converted to hybrid working environments in order to accommodate COVID-19 mandates. The number of challenges that technology created for the credit department also skyrocketed.

71% of credit professionals say more of their customers require the use of web billing portals than before the pandemic. “When I was in the industrial sector, a lot of the bigger industrial companies like General Mills, were using portals to get their information because it was easier for them,” said Joel Shinbrood, senior accountant at Karlin Foods Corp. (Northfield, IL). “They’d have all the information in one place, send remittance invoices and save paper through electronic transactions.”

But Brian Diggs, director of credit at Power & Telephone Supply Company (Piperton, TN) recalls using web billing portals as far back as 2011 or 2012. “It’s easier for payables departments to sort their invoices for each separate vendor, especially for large corporations,” he added.

Diggs acknowledged the headache that comes along with customer payment portals. “For example, a customer could not accept an invoice until it was entered exactly as it should be to their specifications. This, in turn, can cause payment delays when invoices are entered incorrectly at some point during the process.”

New web billing portal systems are expensive and labor intensive to build, implement and train, said Deborah Davis, CCE, CICP, finance systems analyst at Tektronix, Inc. (Beaverton, OR). “There is a lot of training for both internal users and then training your suppliers to follow the new requirements,” she said. “Although it’s a good for the customers, suppliers are now responsible for getting our data into our customers' systems. It can be difficult to resolve when their systems do not work as expected. Plus, it is an added cost to us as the supplier.”

Web billing portals are not the only technology that credit professionals will need to learn more about in the near future. Other core technologies, such as Big Data, cloud computing, Internet-of-Things (IoT) and blockchain are “building a more resilient supply chain management system for the future by enhancing the accuracy of data and encouraging data sharing,” according to World Economic Forum. 3D printing technology also serves to mitigate shocks to the supply chain and offers flexibility in production.

The effects of incorporating more technology are still up for debate. “In the beginning of the pandemic, it was tougher to ensure your staff was performing at their best because everything was over Zoom or Microsoft Teams,” Diggs said. “So, I needed to micromanage more by requiring daily check-ins, etc. However, it created more opportunities for top performers to have more flexibility. In the end, it’s good and bad.”

For better or worse, the credit department will likely continue to become more automated as time goes on. 84% of CFOs’ organizations plan to use automation/digital technologies to free people to use their talents for higher-value activities, according to a study from Deloitte.

Are you interested in learning more about new technology and automation in the credit space? Join the NEW Technology Thought Leadership Group! The first meeting is scheduled for April 11.

Several LIVE sessions at Credit Congress will cover the topic of web billing portals. Find out more about registration here.

You may also enjoy reading these related articles:

The Pains of Customer Payment Portals

Ease the Pain of Customer Payment Portals