Credit management

Definition

Credit management refers to the process of granting credit to your customers, setting payment terms and conditions to enable them to pay their bills on time and in full, recovering payments, and ensuring customers (and employees) comply with your company’s credit policy. It involves setting credit limits for customers, monitoring customer payments and collections, and assessing the risks associated with extending credit to a customer.

A credit manager is an officer responsible for overseeing the credit management processes of a business/company.

Credit collections

Credit collection is the process of covering unpaid balances.

Credit management and collections differ. However, they are closely related to one another and are often managed by the same department.

In some cases, companies may control their own credit management but outsource their collection  process.

This could be because they haven’t got the resources to focus on both, or because they believe a professional collections service is simply better at recovering their invoices and debts.

Components of Credit management:

  • Assessing creditworthiness and approving credit.
  • Setting payment terms.
  • Extending credit to existing customers.
  • Tracking customer credibility.

1. Assessing creditworthiness and approving credit.

A good credit management system can quickly and effectively assess a customer’s financial health and overall creditworthiness. If the assessment process takes too long, there is a risk that the potential customer will find a new supplier. If it isn’t done to a high enough standard, there is a risk your business will take on bad debts.

2. Setting payment terms

This is the practice of deciding when invoices should be paid. Companies often need to strike a balance between offering terms suitable for their industry, the cash flow position, and the risks that longer terms bring. Credit days are usually 10,30,45 or 90 after delivery.

3. Extending credit to customers

Extending credit covers multiple scenarios, including issuing credit notes and offering financing options to your customers.

Credit terms can vary according to the credit or payment history of specific customers.

4. Tracking customer credit

An important function of credit management is the ability to monitor and prioritize your sales ledger or creditor’s aging schedule. This area may crossover       

into the realm of collections.

Benefits of Credit management

  • Cash flow protection: Adequate credit management ensures that cash inflows are always higher than your cash outflows so that the company avoids a liquidity crisis.
  • Reducing the number of late payments by early detection and prevention during the credit scoring process.
  • Executing faster and more complete debt recovery.
  • Improving your company’s Days Sales Outstanding (DSO).
  • Identifying opportunities and freeing up your company’s working capital for critical business investments that can support strategic growth.
  • Credit management is a reassuring management practice for potential investors.

Credit management Strategy

If you don’t have a credit and debt management process in place yet, the following are a few elements you can start with:

  • Calculate your average Days Sales Outstanding or DSO (the average number of days it takes you to collect payment from customers) and compare it with that of your industry.
  • Check if on average you are paying suppliers before payments are coming in. If so, you may need to adjust your billing cycle and payment terms.
  • Maintain a healthy diversification in your customer portfolio so that you’re not relying on one big customer.
  • The whole company should become familiar with credit risk management best practices, which include optimizing contract management and accounts receivable collections, identifying and analyzing the risk of new clients defaulting on payments, and creating a proactive credit risk mitigation plan. You should define the actions you require in credit account management from other departments and make people accountable.
  • Finally, your credit management process should seek a healthy balance between avoiding risk and seizing the opportunity. Being overly cautious can mean missing out on some sales opportunities while being too lax could make you miss the signs of a risky customer.       
  • Establish client creditworthiness.                                          

Being proactive plays an important role in managing credit – in particular, understanding your client’s financial picture.

  • New clients are a welcome addition to any business, but make sure they do not become a liability: identify and analyze their risk of defaulting on payments by creating a proactive credit risk mitigation plan. This is an important step in credit and debt management.
  • Existing customers should undergo a periodic review process. Just because you have a good relationship with a customer doesn’t mean they are impervious to default.
  • Managing credit becomes more complex when conducting business with foreign customers because it can be difficult to interpret and understand information used by foreign countries to measure creditworthiness.
  • When assessing an international client, include country-specific credit risks, such as fluctuations in currency exchange rates, economic or political instability, the potential for trade sanctions or embargos, etc.
  • Support credit and debt management with documentation

 Establishing a contract with a customer

Here are a few tips you should keep in mind:

  • Ensure that sales contracts include your delivery and payment conditions and explain any provisions in the agreement, such as which conditions apply and are acceptable to you.
  • Ask a lawyer to review the conditions upon entering into the contract.
  • Clarify your clients’ payment procedures, policies, and idiosyncrasies and identify to whom you should send your invoices, and ask for acknowledgment of receipt.
  • Invoice early, when work has been completed or services provided. Make sure that your invoice is addressed to the right contact person, company name, and address so it can be treated promptly. Ask the recipient to acknowledge receipt of your invoice.
  • To maximize the chance your invoice will be paid on time, we recommend it includes:
  • Your company name, address, telephone number, email address, and contact name.
  • The purchasing order reference.
  • The nature and quantity of the goods or services.
  • The price in the appropriate currency.
  • The agreed-upon payment period.
  • Your payment details.
  • Your terms are printed on the back of the invoice.
  • Monitor your client’s payment progress.

Despite the efficiency of the above measures, unfortunately, you can’t guarantee your customers will pay their bills within the agreed-upon time period. This is where your credit management policy and credit management services prove essential.

Monitoring your customers' payment progress to make sure they’re complying with your contract agreement can help avoid unpleasant surprises. Review each customer with a frequency that aligns with the perceived risk that the particular customer presents.

In the event of late payments, don’t call your lawyer immediately as it’s important to maintain good customer relations. Start by calling the customer yourself and follow up with a polite but firm written reminder that you are expecting payment within a reasonable time.

But if an invoice remains unpaid after two or three months despite your reminders, consider turning to a professional debt collector, such as your trade credit insurer or a debt collection agency.

And for further help, you can look for additional credit management services. Indeed, although the benefits of credit management are plenty, even a well-defined strategy can’t cover all risks.