In the News
December 3, 2015
The faint hope of economic improvement reflected in October’s Credit Managers’ Index (CMI) is fading, as November data indicate a more dismal state. The combined CMI dropped more than a point to 52.6 this month, with both the manufacturing and service sector indexes experiencing declines.
“This month, the trend has returned to the stress of the last few [months], and the timing is not as it should be,” explained NACM Economist Chris Kuehl, Ph.D. “This is the time of year that the consumer comes to the rescue, but it doesn’t appear that will happen this time.”
November’s combined CMI score is the lowest on record for this year, and Kuehl did not anticipate it would drop this much. Although, when comparing the CMI with other data sets like the Purchasing Managers’ Index (PMI), the figures are similar and reveal economic struggles in many industries. While every number within the combined CMI dropped from October’s reading, Kuehl expressed concern over the index of unfavorable factors, which fell into contraction territory at 49.2. Four of its six subcategory readings have dropped out of the growth area as well.
“Given all the data that has been emerging as far as the economy’s overall strength, this is not a big surprise; but it’s still a disappointment,” Kuehl noted. “It seems that companies are struggling at this point in the year, and that is not a good sign given that this is the time when these companies are expected to make the bulk of their money for the year. This really applies mostly to retail, but the manufacturers respond to that retail drive.”
The drama in the manufacturing sector was not quite as intense, but it still decreased from October’s 53 to 52.3. All of the categories in the index of favorable factors fell, while some of the readings in the index of unfavorable factors showed improvement. The categories of rejections of credit applications, disputes and dollar amount beyond terms increased slightly from the previous month. “There was some expectation that manufacturing would be able to stage some kind of comeback, but thus far the data is still mixed,” Kuehl noted.
The service sector followed a similar pattern and decreased a full two points from the previous month to 52.8. The concern again, Kuehl noted, is the index of unfavorable factors, which fell into contraction territory at 49.0. All of its subcategories decreased in November as well, with the most noticeable drop in accounts placed for collection, which fell from 50.6 to 45.6. “That is a stunning number,” Kuehl pointed out. “It suggests strongly that there are some real issues with many of the companies that credit managers deal with right now as collection action is generally a last resort.”
- Jennifer Lehman, NACM marketing and communications associate
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President Barack Obama signed legislation on Nov. 25 that establishes minimum standards for individual surety bonds to assure that the bonds protect the payment of subcontractors and suppliers on federal construction. It takes effect one year after enactment.
Section 874 of S. 1356, the National Defense Authorization Act for Fiscal Year 2016, prescribes the type of assets that are acceptable and requires individual sureties, which are not heavily regulated, to deposit those assets with the federal government.
While it’s a step forward, some insiders say it’s not a complete solution. “It is very important to remember that a claimant has no recourse if the contract debtor and the surety both fail,” said Jim Fullerton, Esq., founding partner at Fullerton & Knowles, P.C. “It will still be impossible to file a mechanic’s lien on government property. The government has no liability for allowing an insolvent surety to provide the bond or for neglecting to require bonds at all.”
Disreputable bonding companies have been known “to inflate or falsify financial statements in order to meet government qualifications,” Fullerton said. “They will often issue bonds to shady contractors who are unable to obtain other sureties.” Sometimes large premiums are charged as an incentive to provide bonds to risky contractors, he noted. “Such bonding companies can disappear, however, when large claims appear.” Some government contracting officers also have the ability to approve private sureties. “Wealthy individuals are sometimes in the business of providing private surety bonds,” Fullerton said. “Some individuals will also inflate or falsify financial statements in order to qualify.”
Fullerton explained that insolvent private sureties have been a problem on federal projects. “In one local case, private sureties showed vast real estate holdings on financial statements and were approved by the federal government,” he said. “After multiple projects failed, many subcontractors and suppliers filed claims against these private sureties. The real estate on the financial statements turned out to be parkland. Subcontractors and suppliers ended up with judgments against an insolvent general contractor and an insolvent surety.”
In other construction industry news, at least one state will start 2016 with new mechanic’s lien mandates. As of Jan. 1, the Illinois Mechanics Lien Act will include an amendment allowing property owners, contractors, subcontractors or other parties with interest in real property subject to mechanics lien claims to substitute surety bonds for the mechanics lien claim. Bonding off a mechanics lien claim allows an interested party to file a petition with the county where the property is located to bond off a mechanics lien claim filed against the property. If there’s already a pending claim to enforce the lien, within five months of the filing, the interested party can apply to become a party itself and file a claim to bond off the lien claim.
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An index that tracks U.S. companies’ payment behavior indicates a higher incidence of past due receivables than a year ago. Analysts working on Euler Hermes’ latest Payment Behavior Index, which fell 3.6 points over the past year, suggest the change reflects that companies have reported customers either incurred more debt or repaid debts more slowly, or both.
The index declined from 67.7 to 64.1 over the past year. “The deterioration we are seeing in our Payment Behavior Index over the last year has been small but significant, especially given the downturn in the most recent quarter (Q3),” Dan North, Euler Hermes Americas chief economist, told NACM. “But what lends extra significance to our report is that it’s confirmed by nationwide statistics showing that business bankruptcy filings have also deteriorated; filings have risen for two consecutive quarters, the first time since the end of the recession six years ago.”
The risk to receivables is on the rise, North stated. “Credit professionals might want to consider analyzing their own customers’ payment behaviors to identify early signs of trouble and implement a less aggressive risk strategy where appropriate, as well as reconsider whether they have the proper risk management and mitigation techniques in place.”
A PBI above 50 indicates payment behavior is better than average and below 50 worse than average. The index correlates to gross domestic product (GDP) growth, Euler Hermes said. Therefore, the organization expects continued modest GDP growth in the final quarter of 2015—2.5% for the year.
The firm attributes the decrease in payment behavior to a 6% increase in the amount of past due receivables reported by the companies it monitors. In particular, the metals sector experienced “a sharp 97% increase in the amount of past dues largely because of financial distress among providers of pipe, tubing and machinery for the oil and gas industry, a strong U.S. dollar and weak global demand for U.S. metals exports.” Euler Hermes expects the trend to continue until oil prices increase significantly over an extended period, the global economy strengthens further and the dollar weakens.
The downward trend of the metals PBI, a leading indicator of primary metals shipments, “bodes poorly for the industry,” the firm noted. In addition, electronics had a 48% increase in past dues “in line with the fall in retail sales by—4.0% year-on-year, largely because of the stronger dollar lowering the price of imports.” Euler Hermes predicts this trend will continue into 2016. Energy and commodities payments, however, showed improvement due to “much worse conditions a year ago.”
Euler Hermes finds that national data on business bankruptcy filings mirror similar trends as bankruptcies rose in the second and third quarters of 2015. “Although the increases were small, it was the first time since the recession that bankruptcies have risen for two consecutive quarters.”
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In every puzzle, there seems to be a missing piece. Yet, when the picture is nearly complete, it is easier for the mind to imagine what should go in the blank space. Loss is a reality of business, the sooner gotten over and moved on from, the better. Every good strategist, from the poker player to the shrewdest CFO, knows when to say “good grief” and cut his or her losses.
Having the crystal ball to get ahead of losses and factor them into future projections is where the magic lies. The art and science of numbers has been crafted with analytical software that can take advantage of the drift from the ideal bottom line. The following are processes account managers and CFOs can use to beat expected bad debt.
General ledger accounts that are commonly forgotten are aging accounts (aka: allowance for doubtful accounts, bad debt accrual and bad debts expense). The projected estimates for these accounts could come from industry averages, past history, trends or just pulled out of the air. Companies use many reasons and numbers to support these projected estimates. At the same time, they also make plans to decrease uncollected accounts receivable in the future.
Another process to estimate uncollected accounts receivable is the aging method, which uses projected sales by month and decreases revenue by the percentage of uncollectable sales. This method allows the company to see the percentage and dollar amount of revenue that it will not receive based on the number of invoice past due days. This is not a fun process and often avoided like the plague.
Finance, collections and sales departments need to estimate bad debt information and should understand how the estimated bad debt was projected. Now comes the fun part: trying to beat the estimate and collect more revenue for your company, thus making yourself look and feel great. Practices should be put in place to encourage smooth collections on invoices. Like credit and collections staff, encourage the sales team make sure they know customers’ budgets and payment cycles. This way the sales person does not suggest a product that is out of their budget, like the most luxurious car on the lot to a college student. Suggesting products within customers’ affordable budgets decreases the likelihood of the company not receiving payment.
Confidence is knowing you can. Knowing exactly what you can expect to collect is genius. Not knowing where you are going and filling the front end of the coffers with junk sales is not wise, nor is it profitable long term. A prudent company will educate its departments on all available tools and use those resources to the fullest extent. Accounts receivable management software with numbers your team can understand is the bread and butter. Empower your sales and collections departments with the knowledge of how they can work smarter, not harder, together to beat expected bad debt.
- Pamela McDaniel, Dynavistics managing director
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Saudi Arabia is expected to stand its ground at Friday’s Organization of the Petroleum Exporting Countries (OPEC) meeting, despite mounting pressure to rein in production from member countries gravely impacted by low oil prices.
The Saudis have taken significant steps to declare that “under no circumstances will they cut production and give up their market share,” said NACM Economist Chris Kuehl, Ph.D. While oil prices are low and negatively affect the economies of many countries, Saudi producers can still profit when the price of oil is considerably down, and “they know that most of the rest of the world can’t,” Kuehl added. “They know prices are low, but are more concerned about market share and are waiting for the demand to come back. … It’s obviously not the kind of income they like, but it does not require them to shut down operations.”
Saudi Arabia also does not have the clout it once had in the oil industry, especially with the rise of oil production in the United States, Canada and Russia. Even if the Saudis cut production, Kuehl said, it would not likely make much difference—there will still be a glut.
Venezuela, an OPEC country pushing for Saudi Arabia to rein in production, is feeling the brunt of low crude prices. The country's oil revenues account for 95% of export earnings, and its oil and gas sector make up 25% of the country’s gross domestic product, according to the OPEC website. With a parliamentary election scheduled for Sunday, Venezuela is on the brink of a “bitter civil war” if conditions do not change, Kuehl said. A majority of the country’s population lives in poverty, and violence has become a common occurrence. In November, a political opposition leader was assassinated during a campaign rally.
Still, Kuehl anticipates that Friday’s meeting will consist of “the same conversations. The OPEC states are going to scream and yell, and the Saudis are going to ignore them.”
Along with Saudi Arabia and Venezuela, the following countries comprise OPEC: Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar and United Arab Emirates.
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