Comment: Making the Most of Memos

RAPAPORT... Effective inventory management is vital in the challengingbusiness environment the jewelry industry is experiencing lately. Insufficientinventory can lead to lost sales; excess inventory ties up capital and incursfinance charges when merchandise is acquired with loans. For merchants, memos can improve inventory control andreduce expenses. Memo financing is a consignment arrangement: A merchantborrows merchandise from a supplier - a wholesaler or designer - and pays forthe item only after it's sold, or returns it without penalty if it doesn'tsell. This arrangement gives merchants access to a wider product range byallowing them to tap into wholesalers' and designers' stock and acquire itemson short notice. Memos also reduce up-front inventory costs and financingcharges. By delaying payment for the merchandise until it's sold, the merchantfrees up capital and improves cash flow. Suppose the amount of inventory a retail jeweler ownsaverages $1 million. If the jeweler borrowed funds at a 7% interest rate tocover that outlay, it creates an annual interest expense of $70,000, whichcould be the difference between profitability and loss for the year. While memoprices are typically high and could offset what a jeweler saves on interest,taking goods on consignment can expand the merchant's stock without requiringadditional credit. 'Trust but verify' Consigning merchandise creates risks for suppliers. Adishonest merchant might refuse to return the loaned goods, and several recentcases in which the unreturned consignments were valued at over $400,000highlight this risk. Consequently, the borrower's honesty is a key element fora successful memo transaction. Creditworthiness is also important to ensure theborrower can pay for sold items instead of diverting the funds to other uses. "Trust but verify" is a sound strategy for evaluatingprospective borrowers' honesty and creditworthiness. Business references canshare character insights based on their dealings with a merchant. Credit checksand organizations like the Jewelers Board of Trade (JBT) and the DiamondDealers Club can provide information on a retailer's financial condition. Legal safeguards Memo financing poses additional risks to both parties.Suppliers must protect themselves against the possibility of damaged or lostgoods and the prospect of a borrower's bankruptcy, while borrowers want toavoid overly onerous repayment terms or other stipulations that could disrupttheir inventory management and sales. But these risks are manageable, according to Debra Guzov,founder of New York-based law firm Guzov, LLC, which specializes in corporatetransactions and litigation. "Memo financing does not have to be riddled withrisk and uncertainty," she says. "Memos must be, and easily can be, drafted toprotect the interests of both parties." Filing a properly completed UCC-1 financing statement toperfect the supplier's security interest in the merchandise is essential, saysGuzov. ("Perfection" is a legal term for the steps required to maintain an enforceablesecurity interest in a property, meaning the property would be protectedagainst other creditors' claims.) Should a merchant file for bankruptcy, theUCC-1 form prioritizes the supplier's claim over any other creditors', ensuringthe latter cannot use the jewelry as collateral for their own claims.Essentially, the form is a public filing declaring that the property does notbelong to the retailer. Credit checks and careful attention to the memo's detailsare also necessary. "Couple the UCC-1 financing statement with a credit checkand a meticulously drafted memo setting forth provisions for the attribution ofrisk of loss and comprehensive insurance requirements, and any risk inherent inthe transaction decreases appreciably," Guzov adds. A solid future Although some suppliers restrict or avoid consignmentpractices, it's an important financing tool for many jewelry merchants and isunlikely to become less prevalent. It is an established and enduring practice,Guzov points out: "Although there is a risk, properly drafted consignments arean effective business tool providing greater flexibility in the jewelryindustry, and they will continue to be used for a long time to come." How to minimize the risks Memo transactions involve risk, but suppliers and merchantscan reduce potential problems by being diligent about the steps involved: Memos between the supplier and merchant must be in writingand signed by the merchant before goods are transferred. Key components of the memo are specific provisions forpayment, bankruptcy, loss, theft and damage (especially during transit), aswell as insurance requirements. Suppliers must file a UCC-1 statement covering the inventorybefore transferring merchandise, in order to perfect a security interest in thegoods. Both parties must have comprehensive insurance coverage andprovide evidence of the insurance before the goods are transferred. If you are in this business and use memos frequently, it iscost-effective to retain an attorney to provide your company with a template. Thisarticle was first published in the February issue of RapaportMagazine. Robert A. Hoberman, CPA,is the managing partner of accounting and consulting firm Hoberman & Lesserin New York City.