July 4, 2022

Article 2.10


Many small-business firms that have historically depended upon banks for working capital loans are now finding themselves increasingly squeezed for cash due to: stricter bank lending; poor profitability; and slower paying customers. Because banks have been struggling to meet both Federal and International lending requirement ratios, they aren't extending new loans easily and will not until their non-performing real estate loans improve or are gradually written off. Meanwhile, as current bank-line agreements are expiring, banks are often demanding and getting more asset collateral for the same loan amount within the new agreements. The net result has been and will be a net reduction in working capital within the ecological web of small business America - a.k.a., "credit crunch."

Besides the banks cut-back on capital, many firms have had to finance operational losses out of their working capital due to the current U.S. recession; or, they have generated insufficient retained earnings during the nearly three years of zero average growth in the U.S. economy. Because private firms have no access to the public financial markets, the only remaining solutions for cash shortages are to cut costs and liquidate assets often below healthy levels and to pay receivables more slowly. Lengthening receivables can then have a domino effect which ripples and grows backward through supply chains. "I'll pay you when my customers pay me" is commonly heard.


How long will this creeping cash squeeze last? The peak time for cash-crunch severity and bankruptcies within economic cycles typically occurs about 6 to 9 months after an economic recovery starts. If we assume that a recovery will start in mid-1992, then the peak crunch time would be at year-end '92 to mid-1993. The reason for this pattern is that when the economy starts to expand, firms need even more working capital to chronologically finance - more inventory, more work in progress, and greater receivables before those greater receivables are collected with their built in profit margins which can then be reinvested.

Cash crunches can accelerate towards the peak if the recession has been unusually harsh or prolonged. Because many firms have cash reserves going into a recession, they can comfortably weather a normal downturn. The longer the recession, however, the more firms there are that run out of cash and goodwill support with their bankers and key suppliers. If one firm should then fail, it can then take other cash-weak suppliers with it. Given the length of our current economic struggle, we should plan for some larger than normal, negative surprises around year-end '92.


  1. We should become more proactive immediately assuming that we have the rest of 1992 and probably some of '93 to work at minimizing our peak trade credit exposure.
  2. We must next pre-determine how much extra cash we might have to budget for investing in customers' businesses in the form of lengthened receivables. If we are one of the many firms that currently are already in a cash-bind, then we can apply the following suggestions more aggressively to free cash.
  3. We could hire additional full-time or part-time credit collection people who have proven track records at turning around or improving mediocre trade credit efforts. Because trade credit is a universally similar function for all businesses, it doesn't take much education to get an experienced credit person to full speed at a new firm. Excellent people are surprisingly available because they enjoy turnarounds more than maintaining a well run operation. They will respond to ads and searches when a prospective employer is offering top money, a challenge and perhaps a performance bonus. The investment in such extra gun-slinging talent for the cash-flow return can be well worthwhile and maybe a necessary cost for survival.
  4. We shouldn't try to tighten credit demands for all slow-pay customers across the board; instead, we should be strategic and situational. We can segment customers by at least two dimensions - liquidity and strategic fit. Regarding liquidity, there are customers: who can continue to discount; who are having temporary cash-flow problems, but are highly likely to survive long-term; and, those who are chronic deadbeats with risky, unpromising futures.
  5. The strategically important segments of customers are: the core customers who are the 20% of the total who have been generating 120%+ of past operational profits; another small percent of the customers who are the best target accounts for 80% of our future profit growth; and as many as 60% of the accounts which are currently either break-even or money-losing. These last two segments are resource traps for personnel time and working capital.

    The two dimensions for account segmentation can be summarized by the grid below.


    For group #1, good credit collection systems should keep the discounters discounting. With the break-even or losing discounters in group #2, we should decide on an account-by-account basis how to convert them to win-win relationships or let them go to paralyze competitors' resources. We must have the strategic courage to know that all customer relationships must be win-win or no deal. If such accounts leave, then resources can be freed to reinvest back into core and target customers. By pruning the losers we can feed and grow the winners. Temporary sales losses will be offset by: profitable core growth; working capital being freed to pay down debts or support profitable growth; and improved profits.

    Sometimes a new niche of customers can be identified among the losers, and with a new product, service, marketing approach we might create new win-win relations. But, these opportunities take time to develop into profit-generators, and many firms may not have the resources to currently do this.

    With the #3 group of customers, we should dictate new terms for doing business profitably together while being very firm with trade credit. If they leave for activity-driven competitors, then we will redeploy resources more profitably. With the #4 group, we should be opportunistic and ruthless in the nicest way possible to minimize our exposure anyway we can. We can't even be financially sympathetic with core deadbeats(#5) who used to be solid profitable accounts unless we think that we truly owe them something because of their excessive profitability in the past.

    Only a small percentage of accounts, which are group #6 that have a temporary cash-flow problems are the ones that we need to carefully review before possibly betting extra money. And, if we deal with all of the other groups appropriately, we should have both the time and the money to be bet venture investments wisely.

  6. We must, however, be more creative and demanding with the group #6 accounts. These accounts will not typically: forewarn us that they will be slowing payments; or, offer any explanation for why they have a cash problem; how and when they will solve it; and how much they will appreciate our working with them. Most customers just unilaterally take the extra, un-collateralized loan, and when questioned insist that we owe it to them or that we should be sympathetic because their customers do it to them.
  7. Our response should then be to call this loan the venture capital investment that it is and state that we are not unopposed to formalizing a time-limited, trade-credit loan, but we would like some reciprocal considerations such as: their analysis of why there is a cash problem; their proposed solution for solving the problem; and a schedule for repayment. Because many customers will admit to being lax with their own trade credit function, we could then offer them consulting advice or direct them to third-party solutions for improving their credit function. Several good reasons for doing this are:

    a) If they improve their working capital efficiency, then they will be able to finance their future growth which is our future growth too;

    b) They can pay their receivables to us on a timely basis;

    c) and, if we just financed their poor practices the future risk for both of us will increase.

    We should also ask for more financial disclosure to better asses our investment risk, and then ask how we can expect to get an extra return for our incremental investment through: service charges; more volume; higher prices; guaranteed future volume, etc. We shouldn't take a customer's slow payment passively just because they are in the "work with them" category. All of the ideas above are negotiable, especially if we are willing to offer extra or formal, time-based financing plus operational consulting on top of what they may have already taken through slow pay. These extra initiatives are very disarming.

  8. Make the sales-force part of the trade credit solution instead of part of the problem. If they are paid

on volume of sales or margins, they will want easy credit for all customers. Consider educating the sales-force on cash-flow dynamics within a business and on trade credit strategy, policies and practices. Then, install negative incentives for slow pay and write-offs for their accounts. Expecting the sales-force to be more responsible by being part of the solutions for potentially less pay isn't an easy sell and goes against tradition, but then these aren't easy or traditional economic times. We need new levels of cooperation and skills from the sales-force to survive and prosper.


We are in the toughest trade credit environment since the Depression. Cash tightness will accelerate to a peak that will probably occur sometime in early 1993. If we act now in strategic, creative ways, we can reduce our eventual trade credit exposure, and if need be, we can improve credit collections in spite of the deteriorating trend. But, we will have to adopt a new set of assumptions and practices about trade credit, and we must take action immediately.

Merrifield Consulting Group, Inc., Article 2.10