A few weeks ago, a company we do business with underwent a restructuring, which resulted in the formation of a new corporation with new owners. The next day, after the meeting announcing the change, I spoke to one of the principals about the need for a new credit application. His response was very forthcoming but spooky when he said, "Don, your company is the only one to ask for a new credit application; everyone else just wants to keep selling to us." I explained to the customer that a new application would be required, so that all of the terms which are a part of us doing business are approved, and so that we can enter into a legal business arrangement to extend credit. Frankly, the customer was a little miffed that others were not requiring this and we were; however, he signed a new credit application so we could open the account.

Don Magruder Over the last year, we have all heard about banks and their sub-prime lending practices, but it is becoming more evident to me that contractor supply outlets are just as guilty, or worse. Don't forget: sub-prime lending basically means approving home loans for people who do not qualify by modifying terms, fudging information, or counting on escalating home values. If you read many of the quarterly reports from the national suppliers, they talk about huge losses in credit. There appears to be an epidemic of questionable lending in the industry. In their quest for sales, many companies are abandoning credit standards to open an account for anyone with little to no verification.

If tomorrow, you or I were to go to the bank and ask for a $100,000 line of credit, the bank would require multiple signatures, multiple guarantees, collateralized property, and at least a pint of blood. However, each day subcontractors and contractors will come into our places of business waving a potential order, and many of us will open up $100,000 lines of credit with barely a signature. Our industry's credit policies are worse than those sub-prime lenders, which created this current economic meltdown, and many companies in our industry are flirting with bankruptcy if they do not quickly change their ways.

Here are some credit standards you may want to review at your location:

  • Do you have a credit application for all of your customers, and are they updated and correct? Many companies have changed names and ownership, and the courts do not give you a break just because you did not do your job to secure another application. You must exercise due diligence with managers and salespeople to ensure all changes by your customers result in new credit applications. One changed word in a name means a new corporation that is not bound by an old agreement.
  • Just because you have an application doesn't mean it is correct. A part-time receptionist, who is not a principal of the corporation, cannot sign it nor does she have the capacity to cover a personal guarantee. You need to make sure the type of application is correct, the principals are correct, and someone who is authorized has signed it. If you fail on any point, then future claims could be in jeopardy. Don't forget; new owners in an older company may not be creditworthy.
  • Where is your material going? Individual jobs should be set up on all materials with good legal descriptions. If you are in Florida, you must file a Notice to Owner within 45 days of the first shipment of materials or production of the product. It is imperative that salespeople are trained to put material orders on the correct job in an effort to protect lien rights.
  • How do you know the job is funded, and by who? The biggest mistake many companies make is they do not verify funding on a job. This is a big problem for established contractors. How many times have contractors and suppliers began jobs, only to find out that financing was tentative and not committed? After you have shipped $100,000 in supplies is the wrong time to find out there is no financing or money for the job. Call the bank for verification.
  • If you have terms on the back of your application, you should have a space for the person signing to initial it as well, showing that all terms are acknowledged. One major reason a new application is necessary is because of the terms it carries if the account goes bad. For example, one of the terms we have at Ro-Mac Lumber is that a signature is not required on all invoices because of jobsite deliveries. The first question a lawyer will ask in a non-payment dispute is, "Where are all of the signed invoices?" Failure to have your terms approved by the correct party will jeopardize your position in court.
  • The other major problem we have in our industry is opening garbage accounts. If a customer has liens, a $200 balance in the 90-day past due column, and excuses his bad personal credit to a divorce, he probably does not deserve to have an account opened. However, each day people just like this get a credit account opened at their local building supply outlet. When I see a person's credit report, showing a $200 balance in the 90-day past due column, that concerns me more than someone who has $10,000 in a late column. Companies must establish a mentality of real risk versus reward on accounts, and the credit department cannot be run by anyone in the sales department.
  • C.O.D. stands for Cash on Delivery. It does not stand for a floating account because the customer is not credit worthy. Managers and salespeople must understand illegal C.O.D. accounts and back office drawer accounts holding tickets are offenses worth a paycheck withdrawal or being fired because of the legal jeopardy it leaves the company in. Those who engage in these types of shenanigans always get caught--they should have never let the customer get them by the short hair.
  • Salespeople should be included in the collection process and their pay should be dinged if any account goes bad. I do not accept the principle that a person cannot sell to and collect from a customer. That's a bogus argument made by a weak salesperson. A salesperson who is vested in the collection of an account will speak loudly when he sees warning signs of customer failures. In my view, the salesperson should work in tandem with the credit department and be available when the situation calls for it.
  • If you look at your trial balance report today versus just five years ago, you will see almost 60% of your old accounts no longer exist. Everyone should realize this industry is riddled with people going in and out of business, and there are real credit risks. Trust in contractor credit is not in abundance.
  • Hold a weekly credit review with your managers and salespeople to go through your company's trial balances. Inattentiveness and covering your eyes in today's environment will lead to huge losses. Executives must be prepared to make hard decisions, such as putting a customer on hold or taking legal collection action when an account becomes delinquent. You're playing for keeps now, so you need to have the stomach for it.

In the last 30 years, I have heard one story after another from executives on how contractors cost a company thousands of dollars, as if it were the entire contractor's fault. I disagree with that premise in many of those cases because the executives ignored the signs, had poor credit controls, and lacked the discipline over the zealots in their sales department. Don't get me wrong; the bad credit customer knew what he or she was doing, but the executive was a willing participant.
This economic turndown has taught a lot of lessons to a lot of people, but many of the hardheads in our industry still haven't learned. Building material dealers are not sub-prime lenders, banks, or pawnshops; you must be paid when payment is due. For many dealers, it is too late to institute good credit policies because the For Sale signs are up, but it is never too late to start treating credit like it should be treated: professionally. Our industry must go beyond the "slap on the back" way of credit and institute higher standards. It will be good for all of us, as well as the entire construction industry.

Don Magruder is general manager of Ro-Mac Lumber & Supply, Leesburg, Fla., and is a past chairman of the Florida Building Material Association. This article originally appeared in the Nov. 12 FBMA newsletter.