Overcoming a Deficit in Your Exchange

This is a post from a guest author, Jim West of Olympus Media. Enjoy!

Overcoming Deficits in the Barter Industry

by Jim West

In the last thirty years that I have been in and around the commercial barter industry, a common problem among trade exchange owners has been the existence of a deficit in their exchange. By definition, a deficit happens when the liabilities of a trade exchange (positive trade dollar balances) exceed the assets (inventory or negative trade dollar balances).
When a barter exchange opens its doors for the first time, the operator’s challenge is to begin signing members. Since revenue for the exchange is derived from the movement of trade dollars, the motivation is to get as many trade dollars on the street as quickly as possible. Where do these new members get trade dollars to spend? The only two methods that are considered fiscally sound are to either acquire hard goods into inventory and issue trade currency when you “put gold into Ft. Knox”, or grant lines of credit. Since most exchange operators find that managing a warehouse of inventory can be costly and unprofitable, the most accepted way of capitalizing a trade exchange is by granting credit lines. This is commonly known as a zero-debit accounting system.

In reality, a barter exchange is nothing more than a mini pseudo-bank, the difference being that it does not accept cash as deposits nor is it regulated by the Federal Reserve. With that in mind, the balance sheet of a barter exchange should be managed much like a bank’s balance sheet. The members deposit goods and services in lieu of cash and receive a credit in their account. That credit becomes a liability to the “bank” and the member/depositor becomes in essence a creditor of the exchange. When a line of credit is granted to a member, they become a debtor to the exchange and their debt is an asset/receivable which offsets the positive balance liabilities/payables. In a zero-debit accounting system, the balance sheet should actually balance. If the operator is making a profit there should actually be a net worth, whereby the assets have been managed in such a way that they exceed the liabilities. Should an exchange operator ever decide to go out of business or retire, in theory all positive and negative balances should be able to net out against each other leaving a zero balance in all accounts.

Because barter exchanges are not regulated by any banking authority, there always exists the opportunity for abuse. Far too often, the barter industry attracts unscrupulous operators who view owning a barter exchange as a license to steal because they can actually get away with printing money. In contrast, I have found that some exchange operators are actually ignorant of how their own company is supposed to work and don’t have a clue what a deficit is or how it came to be. This second group is who this article is written for since we can assume that the first group already knows what they are doing.

The problem

How does a trade exchange get into a deficit position? This usually occurs when the operator loses control of trade spending and begins issuing trade dollars at will for whatever business expense comes along, for payroll, for new membership incentives, or for their own personal spending. Their rationale is usually that they are earning trade every month in the form of some kind of monthly accounting fee and it will eventually balance out. What they don’t realize is that they are actually printing money and spending more than they earn. Over time, this reckless practice can snowball until the resulting deficit is so large that it is out of control. On a larger scale, our own federal government is a good example of what happens when deficit spending runs rampant.

Another cause for a deficit is mismanagement. This usually runs alongside deficit spending but it can sometimes occur on its own. Not having a reserve account for bad debt can result in a deficit. When a member goes out of business with a negative balance, the exchange can end up with a loss. Write downs on obsolete or inflated inventory can also result in losses.

Were the members (depositors) to get wind of the existence of a large deficit in their barter exchange, what could result would be similar to a run on the bank and the ensuing chaos that usually results when a real bank defaults on its obligations. Trading could come to a standstill and even worse, a group of “creditors” could get together and force an exchange into bankruptcy if there were enough discontented members. What many exchange operators with deficits don’t realize is that if they were a real bank, the regulators would have shut their doors long ago, and worse yet, they would be behind bars.

The solution

The first action that must be taken to reverse the deficit process is one of acknowledgment. The operator must come to grips with what has occurred, how the problem developed and what behavior needs to be changed to prevent it from continuing. Once an assessment of the problem has been made, the extent of the deficit and a true balance sheet created, a solution can then be implemented.

The traditional method for erasing a deficit has been to pump new product into the system, which when purchased at wholesale by the operator could earn back trade dollars with a retail markup. This requires a cash commitment on the part of the operator to acquire salable hard goods and could also compound the problem further if new trade dollars are issued to acquire products in bulk on trade. This process can be time consuming and many operators who have already made a mess of things are usually not equipped to ramp up a merchandising division like this and make a profit. Also, the result of earning back trade dollars and erasing them from the balance sheet can be a huge reduction in the amount of currency in circulation and therefore an impact on trade volume and fees. While in theory this could work, it is not the method that I would pursue.

The first problem that must be addressed is the level of trade spending going forward. Here’s where a simple budget is needed. If the monthly trade income is not sufficient to cover the monthly trade expense, some adjustments are needed. Trade compensation to employees, operating expenses paid in trade, and an allowance for discretionary trade
purchases must be covered by trade income. If trade income from monthly accounting fees is not sufficient to cover these expenses, either the expenses must be reduced or trade income must be increased. I recommend a combination of both. Abuses in trade spending must be curtailed and strict guidelines enforced. Treat trade like it was cash just like a member’s negative balance would be if they closed their account. Then, try adding a trade component to the transaction fee schedule by perhaps reducing 1% of the cash fees in exchange for 2.5% in trade or by offering some new value to the member in order to increase the fees by a trade portion. The member will welcome a reduction in the cash fee portion and will appreciate your willingness to accept trade which reaffirms the value of your own trade currency. This new trade income will serve to balance your trade spending budget going forward as well as whittle down the deficit over time. The concern over the potential reduction in cash income can be overcome by a look at the whole principle of Reaganomics that turned our economy around in the 80’s. A reduction in the cash fee component could very well result in higher monthly trade volume as members view the service as being more affordable which further translates into higher monthly fee income.

A bigger impact on the deficit dilemma can also be achieved by taking trade dollars out of circulation and thus reducing the liability exposure. No, I’m not advocating confiscating members’ balances. This method doesn’t really remove the liability from the balance sheet, but it does hold it in suspense accounts with the member’s consent to minimize the potential for a “run on the bank” and the resulting gridlock that may ensue.

There are two industries in particular which provide an intangible product that is paid monthly over time: Media and Real Estate. Most advertising contracts are for periods of time up to a year. Real Estate leases can be for as long as three years or more. Both of these industries have huge excess capacities right now and their product is perishable. And, these types of companies usually employ an accrual accounting system which means that they only want to be paid monthly as the service is rendered instead of in advance. However, because you want to make sure that the advertising member or Lessee member meets their future trade obligation on their advertising contract or Lease, the opportunity exists to have them prepay the entire contract in trade and then deposit those funds into a suspense account from which the monthly obligation would be paid. This accomplishes several things for the exchange. It generates huge trade volumes on the buy side resulting in a spike in cash and trade income, it removes large amounts of trade from circulation into suspense accounts and releases it back into circulation in manageable increments, and it serves to reduce high balance accounts in a hurry which are the worry of many exchange operators.

There will be times when a member wants to advertise or lease real estate without the trade funds to fully do so. That is fine. Here’s an opportunity to grant a line of credit and start backing up the exchange’s liabilities with like-kind assets. Just make sure that you do proper due diligence on your member/debtor and end up with a well secured receivable. You can also attract new members easily when you have the right kind of media and real estate to offer. Granting credit lines to new members that must be paid back with new business creates new activity among existing members, also generating an increased level of cash and trade fees.

What kind of media and real estate is ideal? Depending on the size of your exchange’s deficit, go after media which requires a sizeable monthly commitment. While we believe outdoor is the most effective, it is also the most costly even though it is also the most economical in cost per prospect reached. Find real estate firms that own and operate shopping centers and office buildings. All you have to do these days is drive around and notice all the vacant spaces. A retail or office lease directly offsets a member’s monthly cash expense so it would be in great demand. The real estate company needs incremental trade income to offset their monthly maintenance costs because they are hurting for cash flow. When you consider the big picture, this is a win-win for all concerned.

Back to a Balanced System

With these processes in place, you are on your way back to a balanced economy within your exchange. It’s important to always think of yourself as a bank and more importantly, as a banker. Be ever aware of your liabilities to your members. They have entrusted to you thousands or maybe even millions of dollars in assets to manage and you have a fiduciary obligation to do so responsibly. As you progress towards fiscal soundness, be thinking of ways to demonstrate to your members the commitment you have made towards a balanced system. Who knows, you may someday be proud enough to actually publish your balance sheet for your members’ review, much like a bank does. There’s nothing like accountability!

Jim West is a veteran of the barter industry and currently serves as Corporate Barter Director at Olympus Media, LLC. You may contact him at jwest@olympusmediallc.com or 678-514-5514.

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6 Responses to “Overcoming a Deficit in Your Exchange”

  1. Annette Riggs
    September 5, 2011 at 12:18 pm #

    Thanks for this article Jim. I appreciate you taking the time to write it and bring forward an issue that is so important to our industry and too often ignored.

    Some of the largest trade exchanges (especially franchisors) don’t teach these basics and in fact some are teaching that positive balances are assets rather than liabilities.

    There are tax and accounting issues that need to also be understood related to some of your suggestions here and there will be sessions on all of this at the upcoming IRTA conference September 19-21. There will be a lot of great materials that will be published following the convention so for those of you that won’t be attending, please stay tuned and check the website http://www.irta.com

  2. Ashby Green
    September 5, 2011 at 6:39 pm #

    Well written Jim. These are some positive approaches to handling a common problem within our industry.

  3. Ross Porter
    September 6, 2011 at 6:21 pm #

    Thanks Jim! I would not say this is a common problem in the barter industry, only for exchanges which lack the morals and integrity to run a proper exchange. The “exchanges” who simply don’t care to protect their members, their large trade balances which the exchange helped to create, would fall under the word “common.”

  4. Ross Porter
    September 7, 2011 at 5:03 am #

    I purchased a trade exchange franchise region with 61 “active” accounts” that had not traded for at least a year and for some of them, much longer. There were positive balances in the system that totaled $350,000. and there were no negative balances. There were some zero balances but no negatives – no credit lines (eventually they approved one after my member and I put up a personal guarantee). I didn’t have previous experience in the barter industry and in essence I was told that negative accounts were bad for my exchange (I considered those “deficits”) and that I needed positive balances in order to have a strong exchange. Since franchisees don’t manage the back end of the exchange – no one ever questions that assertion. I was a top performer and won awards for my accomplishments on several occasions. Even though I met goals and got the numbers that they told me I would need to make the money promised – it didn’t happen and I began to question the company and the representations that were made to me. I started talking to people in the industry outside of the franchise network I was in and one of the first things I learned was that I had been given a lot of false information. Now that I know up isn’t down– I’m wondering what those of you on this discussion with a lot of experience think of my circumstances. Do you consider this ethical practice? Did I purchase anything of value or how would you value the scenario above? Is there any argument to support their assertion that positive balances are assets? Besides the fact that most of the franchises fail or at minimum don’t go anywhere– are there other consequences? I know a lot of other people in the same boat I was in and can’t believe that this company has gotten away with this for so long.

  5. kevin miller
    September 7, 2011 at 8:17 am #

    So what happens to my trade dollars when the exchange fails or nobody is taking any more trades?

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