By T.J. Comstock, owner of Northwest Hardware, LLC
Recently I was talking to a fellow hardware retailer and we got into a discussion about accounts receivable (A/R) levels in our stores.
I mentioned what my levels were and he seemed genuinely shocked that our store’s A/R levels were so low (about half of his on comparable sales). As we spoke, I realized that perhaps there is some outdated logic on A/R in our industry.
Why You Have It
Odds are if you own, bought or inherited a hardware store in a small- to medium-sized community, you may have some A/R. The real question is, why do you have it? Prior to the 1990s, most retailers gave credit to good customers as a convenience. Stores that didn’t give credit were at a major disadvantage to those that did on that basis.
Customers could come to the store without a checkbook or cash, receive goods and know that they had several weeks to come up with the money to pay for it. If you were in business during that era, or your parents/previous owners were, odds are they had to play that game.
However, is it still necessary for a ground-up store, new owner or even an existing store to continue this practice? Probably not. The reality is that most hardware retailers still have high A/R because they are afraid discontinuing the practice will cost them customers.
Let’s look at this objectively. The reasons consumers choose one store over another for a variety of reasons, including customer service, convenience, location, layout, price, etc. Another factor driving their decisions may or may not be the ability to have an open charge account. Frankly, if the only thing holding your customers’ loyalty is a charge account, then I would advise you to stop reading this article and take a long look at the rest of your business.
If you’re still with me, ask yourself, ”If I were opening a new store today, what policy would I put in place on house charge accounts?” I’d argue a great place to start is back where our parents, previous owners or possibly even you did some time ago, and that is asking this question: To whom should I give a charge account and why?
In asking myself that question when we started several years ago, I determined that two groups should have the ability to charge at my store. Those are municipalities (state/local government organizations, schools, county maintenance, etc.) and businesses that had more than five employees and were a recognized entity.
The underlying logic was that it is not easy for these two customer segments to obtain or keep track of credit cards. From that decision point, we set our policies and internal criteria for opening accounts.
Three Fundamental Changes
There are three things in our industry that have made the practice of carrying a large A/R obsolete: credit cards, box stores and cash flow.
First, the invention of the magnetic strip reader, transactions by phone (now via the Internet) and major credit companies have made credit card usage skyrocket. Today, an 18-year-old college student without a job can secure a $1,000 line of credit over the phone.
And with the introduction of “points” earned with every purchase, credit card use is accelerating. Electronic transactions are quickly becoming the payment method of choice in most businesses.
Changing your A/R policy is not going to end your relationship with your customers. All it is going to do is move customers from one mode of utilizing credit (your A/R) to another (using their credit cards). Credit card companies get paid to handle transactions and to go after people who don’t pay their bills.
These companies are also a lot better at judging credit risks. I hate paying credit card fees in my business; however, it would be substantially more expensive for me to achieve the same sales and manage numerous accounts should I choose to offer in-house credit instead.
Additionally, the big boxes have reshaped consumers’ expectations of in-house credit. Home Depot, Lowe’s, or Menards are not going to open an in-house charge account for your customer. Yes, they have credit cards that a customer can sign up for, but these cards are far more like a Visa card than an in-house charge account.
If you are in a smaller community with a fellow independent as your competition, do you really believe he is in the business of opening up new personal charge accounts? My guess is that he is not. Even if he does, there was a reason why that customer chose your store to begin with and will probably quickly remember that reason when he is shopping there. If your competitor does choose to open that account and steals that customer, then you just handed them someone who elevates their exposure to risk and lowers yours.
Charge customers are expensive customers to have; if you have to lose a customer, those are the ones to lose.
Finally, cash flow has changed considerably in all retail businesses. Years ago, your banker looked at how many dollars in inventory you had, how much equity there was in your building; if you owned other assets, such as real estate; etc.
Today much is the same. Bankers continue to look at the balance sheet closely to make sure you are meeting key ratios. However, anyone who has been to the bank in the last 10-plus years to get a loan or a line of credit knows that what the bank really focuses on is your cash flow. Cash flow is king and looks to reign for quite a while.
A/R is one of the things that can be very damaging to your cash flow if not managed properly or planned for. If you expect to have an average A/R balance in your projections of, say, $50,000, you had best plan to finance that cash in your original loan package. Otherwise, that money will come directly out of your checkbook within the first few months and will never return unless you close all of your accounts, which I would not recommend.
Speaking from experience, I opened three stores in my first three years of business. Two were existing buyouts and one was a ground-up. After buying the two existing stores, we immediately sent out a letter to all existing charge account customers, clearly defining our policy and including a credit application for them to fill out. Not one of the previous personal accounts asked for credit, and all of the municipality and business customers were happy to comply.
Those personal accounts that we closed continued to shop with us—one of the two stores was my father’s, and I knew the people who held those accounts. All of them continued to shop with me. Several of those customers told me specifically that they understood our change in policy and preferred to use their credit cards anyway.
The bottom line is that change is hard, and oftentimes we retailers build things up in our minds to be a lot bigger deals to our customers than they are. Review your accounts and look to see if you can possibly revise your policies to reduce your A/R and ultimately increase your available cash flow.
If you are not comfortable with just axing all personal accounts at one time, perhaps develop a plan that is executed over several months that allows you to discontinue charging to specific groups of customers.
Otherwise, take the Band-Aid approach and simply make the change on who qualifies for charge accounts and eliminate the rest. You may even offer some incentive to them, such as a discount on their total bill, if they pay in full and close the account. However you do it, aggressively reducing your accounts receivable will provide your business with greater cash flow, less administrative expense and possibly make it more sellable in the future.