eCredit Whitepaper: How Scoring Can Prioritize Collections
Scoring as Collections Performance Driver
Scoring has been a very hot topic in the credit world over the past 3 years. Many issues have been driving this trend including Sarbanes-Oxley compliance, lower technology and modeling costs, and better education on scoring through groups such as the Credit Research Foundation and NACM.
A recent survey of America's top companies by the Credit Research Foundation showed that over 30% of the companies that are not currently using scoring will implement it over the next year and that over 40% of the companies that are not currently using scoring will implement it within the next 1-2 years. While this trend is encouraging and scoring is being increasingly recognized as a value-driver within an organization, many companies are missing a tremendous opportunity to further lower DSO by not utilizing and factoring a customerÃs credit risk into its collection strategies. In fact, the same study by the Credit Research Foundation showed that only 21% of the companies utilizing scoring used it for collections prioritization.
Today, most companies collect on all accounts based on paper aged trial balances, working from right to left on the aging report, not considering the risk of the account, just the past due balance. In a manual environment with existing resources, this is the best strategy to collect on those A/R balances that will have the biggest impact on DSO. However, in an automated environment, a company can touch many more accounts (through phone, email, fax and letter correspondence), which allows for more strategic ways to prioritize your collection activity. The credit risk scores generated today will help your organization prioritize resources and drive collection policies to help optimize recovery in the future. Utilizing scoring to prioritize your collection strategies, at a high level, requires three steps:
- Risk score your account portfolio
- Utilize software to prioritize the accounts to call
- Developing collection strategies to optimize recovery
The first step is to assign a risk score/collection recovery score to a portfolio of your accounts. Risk scoring a portfolio of accounts can take many forms. Your organization can utilize its own rules/judgmental based scorecards; utilize a 3rd party to develop a custom statistical/behavioral based scorecard(s); and/or utilize the current bureau statistical scores to score your accounts. Regardless of the model used, the risk score should determine both the willingness and ability of your customer to pay its bills. Factors used to identify risk in scoring models include:
- How the customer currently pays other companies (e.g. D&B Paydex score; Experian Average Days to Pay Score)
- How your customer pays certain industry groups (may be more relevant to understand how a customer pays bills to your competitors)
- Size and stability factors such as Years in Business and # of employees
- Public Record data such as number of A/R and Inventory secured UCC filings, suits, liens and judgments
- Financial data/ratios to determine liquidity, leverage, profitability and efficiency
- Finally, the best indicator, and that is how the customer is currently paying you and what historic payment trends look like The data bureaus also have statistically validated risk scores associated with all their accounts.
These risk scores are available on most of the standard reports that are used today. In lieu of utilizing a scoring model to assign a risk score to a portfolio of accounts, you can utilize these risk scores from the data bureaus, which can be appended to all your accounts to determine both risk of slow pay and risk of going out of business. Examples include:
- D&B Credit Score predictor of slow pay
- D&B Financial Stress Score predictor of default
- Experian Commercial Intelliscore predictor of slow pay
- Moody's KMV predictor of default
Utilize Software to Increase Productivity
Time studies have shown that collectors in a manual environment spend the majority of their day doing the following:
- Preparing who to call
o Includes pulling and interpreting reports and aged trial sheets
o Toggling between systems to get the most current information and summary level information on the account to be called
- Documentation, Reporting and Follow-up
o Examples include: creating call notes, management reports, faxing/mailing out correspondence, follow-up reminders, dispute resolution, etc.
Collection software solutions are geared to automate most of the above activities, which allows the collectors to spend more of their time making collection calls. The software tools organize a collector's day by organizing/prioritizing what accounts need to be called based on the consistent collection policies of your company. Those accounts/invoices are exposed to a collectorÃs work queue every night and throughout the day so when the collector comes in to work they know exactly what invoices need to be called and why. The software will also automatically generate letter correspondence to your customers based on how many days past due the invoice is. This is one way a company can touch more accounts using automation. Traditionally, the work is pushed out to the collectors for a manual phone call have been based on strategies that include company type (e.g. size, industry, etc.), past due balance (e.g. higher balance = higher priority) and days past due (e.g. 60 day bucket, 90 day bucket). Factoring account risk in the collection strategies will allow your collectors to spend their most productive time (phone call work) on those accounts that are the highest risk of default.
Developing collection strategies to optimize recovery
Study after study has shown that the more an invoice ages, the more difficult it becomes to collect on that past-due balance. Being more proactive and aggressive on your high risk customers will improve overall collector performance and company DSO. Today's best practices include incorporating your credit risk score (collection recovery score) into your collection strategies for more appropriate treatment of your accounts. This practice has been utilized by leading collection agencies for years. When they receive a placed for collection file they immediately risk score the account portfolio and prioritize their calls based on risk; the lowest risk customers are called first and time permitting the higher risk customers. This is because the recovery rates are much higher with low risk accounts. A collection agency, similar to a collections department, knows the value of phone correspondence and through a risk strategy can maximize their call effectiveness. The ability to adopt a more aggressive collection policy towards your high risk accounts will improve the likelihood that the account will pay its obligation. An example of a collection strategy using risk as one of the criteria is shown below:
As seen in the example above, a blend of phone call and letter correspondence is used to collect on certain accounts. The example also shows prioritizing calling high dollar/high risk accounts first, which is where a company should focus its limited resources. An ideal situation would be to call all past due invoices on all your accounts. The reality is that the collection department only has so many resources and number of phone calls it can make per day.
Due to compliance and the need to improve risk performance, many companies have adopted scoring. While many companies are using scoring for risk analysis, very few are using it for collection prioritization, which also has many benefits. The three main benefits are:
- Allow the collectors to make more collection calls per day
- Touch more accounts and go deeper in account base by making more calls per day and developing a letter correspondence strategy on all accounts
- Maximize call effectiveness by always focusing on high risk dollars first The result of the above benefits is improved productivity, lower DSO, and lower bad debt.