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In a perfect world, homeowners and business people would have enough in their savings to maintain life’s necessities such as warm homes and flush toilets. In the real world, according to the Bureau of Economic Analysis, we manage to spend 97 cents of every dollar of income. On top of that, we Americans carry close to a trillion dollars in credit-card debt.

In a race for wealth, a homeless person living under a bridge would be ahead of many suburban homeowners simply because his or her net worth (perhaps $2.45 and half a pack of smokes) beats the negative worth of a homeowner who is upside down in his mortgage and driving a $30,000 leased automobile. There’s not much of a rainy-day fund in that picture.

Credit cards, long the homeowner’s first line of financing for repairs, are now facing significant restraints. Credit limits are being curtailed, interest rates and fees are going up and often consumers are finding that they’ve already bumped into their maximum line of credit and can’t even charge a spring tune-up.

The belt-tightening isn’t limited to credit cards. Homeowners accustomed to tapping their home equity line of credit or who want to refinance to withdraw home equity are finding out that they aren’t really homeowners after all. The home, or more accurately, the finance company owns the homeowner.

Blind to all these financial challenges, water heaters and furnaces continue to age. They fail despite whether there’s money in the bank. Paradoxically, cash-strapped homeowners could benefit from replacing their old equipment in order to reduce operating expenses. This poses a real dilemma for contractors. You are faced with customers who have bigger needs than their budgets allow. If they can’t buy, you can’t sell.

Perhaps you can help your customers get what they need at a price they can afford while at the same time improving your production efficiency and margins. Perhaps you can become a credit contractor.

Banking Simplified

Here’s a simple, perhaps oversimplified way to look at the lending business. Bankers use your deposits to make money. They keep part of it on hand to cover withdrawals and overhead, and invest the rest in loans and other instruments. They charge borrowers a lending rate, pay you a few percent for your capital and keep the difference.

As I write this, a 1-year Certificate of Deposit pays just under 2 percent, while a fixed-rate mortgage is about 5 percent. In other words, the banker gets a bigger bite than you do. Even though bankers have overhead nibbling away at their margins, they still manage to make good money off your cash. The major point here is that lenders use cash to make more cash. All they need is some “seed” cash.

Be Credit-Worthy To Offer Credit

Our banking system ran into problems because politics encouraged lenders to ignore basic tenets of lending. Taxpayers ended up bailing out many of these bankers. You won’t have a bailout option like the big banks received, so don’t extend credit if you don’t have cash in the bank. Cash cushions the blow whenever a loan goes bad - and some loans will go bad.

If you have already been operating on borrowed money, you’ll compound your problems with a lending loss. You won’t be able to pay your notes on time and soon you’ll become property of your lender. Without your own cash reserve, you should focus on c.o.d. sales and increasing your margins.

Use the additional profits to build up your capital. In fact, you should get started on that right now. The rest of this column is not even worth your time. If you do have cash in the bank, and are not terribly risk-averse, then read on.

Make More Than The Bankers

The banker’s primary source of revenue is in the difference between what they charge their borrowers and what they pay to depositors. Borrowers are constantly shopping for lower rates; depositors are constantly shopping for higher rates. The bankers are squeezed in the middle.

For a savvy contractor, lending offers several additional revenue streams and better returns than bankers can get. For starters, your effective interest rate will be higher than what a bank gets. A 1.5 percent interest on monthly balances works out to 18 percent annual interest on anything carried for a year or more. This is a better return than what banks get for loans. But from a consumer’s perspective, it’s a bargain when compared to the 30 percent rates charged by some of the big credit card companies.

Perhaps a bigger revenue resource, but much more difficult to measure, is improved production efficiency. Historically, credit customers buy more. They buy the upgrades and additional services because the sting of the high price is spread over several months. If they buy with cash, they’re more interested in conserving cash than they are in upgrades.

Remember, the statistics say that we’re saving 3 cents on every dollar earned. This means that a $100,000-a-year household may have a whopping $3,000 or so to spend on surprise repairs. If you make it easier for your customer to get a new condenser instead of just a fan motor, your sales and marketing efficiency improves dramatically. The interest earned on the transaction pales in comparison to the added efficiency of selling more production hours.

Keep in mind that opportunities to increase daily production expire at the end of each day and above-budget production is not burdened with overhead, making it the most profitable work you can do. It’s difficult to count “missed opportunities” but let’s examine some hypothetical numbers.

Let’s say your budget is based upon 1,000 production units per truck annually and your cost per production unit is $250. You’re earning a 30 percent net on these production units, so sales (labor only) would be about $357,000 per truck. If, because of your credit plan, you could increase your production by just 10 percent, you would be adding nearly $36,000 to the sales for that truck - almost a month’s worth of revenue with very little additional overhead expense.

Reduced Competition

If you’ve been managing your business properly, have cash in the bank and positive cash flow, you’re in the minority of contractors but this has little effect on the size of your customer base. You’re still competing with less-savvy contractors, as well as just about every consumer-based business on the planet.

By offering in-house credit, you are on a different playing field, one where “the other guys” can’t compete. By filling this void in the market, you gain deeper market penetration, higher margins and improved production efficiency.

The Fine Print

I am not necessarily advocating credit contracting. In-house financing is a game for business people, not struggling contractors. If you have the resources to be successful in the credit game, then it may be an opportunity you want to explore.

If you choose to offer credit plans, consider starting small. Perhaps you can offer financing for specific replacement items. You can also put a dollar cap on how much credit you’ll offer in a given period.

Consider increasing the bad debt line item in your budget, then offering cash discounts for your c.o.d. customers. It will be up to you to adhere to the documentation and other legal requirements of your particular state. In some areas, the paperwork may not be daunting; in other areas, you may just want to leave it up to the financiers.

Fundamentally you need to remember that lenders take risks to make money off of money. Risk implies that you can, in fact, lose money. There are ways to mitigate these risks but you will have jobs that go bad. Plan accordingly.