The Credit Department plays an integral role in the operations and profitability of the company. At times, you may feel at odds with your sales team, as well as upper management, as the gatekeeper of the company’s purse strings. Real product goes out the door on your approval and if payment is late, or worse, uncollectible, your margins go out the window. You’re constantly juggling your need to make smart credit decisions with the sales team’s incentive to increase sales. Even though there are differences, credit and sales should not be viewed as competing areas, but rather as key players in any Company’s working capital management operations.
So what backs you up when presenting your credit decision rationale to the sales executive or your CFO? The concept of a credit policy is not outdated and, in fact, is critical to the operations of the credit department. It’s time to create, revisit or restate your company’s policy to be sure there are clear, concise requirements of credit extension that can be communicated company wide.
So, where do you start?
1) Understand your company’s risk tolerance:
This is often tied to margins; which may vary by region, division or product line and even the overall size of the business as relates to the balance sheet. You’ll need to consider industries/countries into which you’re selling and competitive factors which will also have an impact on risk.
2) Goals of the department:
It’s all about the credit metrics, such as average days to pay or estimated days slow within certain range, % bad debt under certain level (mix of credit extension vs credit card), average age of past due invoices, average age of deduction balances, and cash in advance or cash on delivery. Auto-rate below a certain sale value and define exception rules that require an over-ride or intervention of a supervisor. Working directly with management can often help you to define the best combination.
3) Setting Terms:
Consider the industry standard; do most offer discounts if the customer pays early? Do you want to set to 30 day terms as is common in many industries in the US? What is the Competition/Industry doing? How much flexibility do we have, given our margins? Can we do better than the competition? Any question that you think is relevant to be asked, should be asked.
a. According to Steve Renschen Director, Collections at Olympus Corporation of America, another focus should be to outline a strategy regarding terms exceptions. This includes situations like bulk deals, specials, closeouts, and slow moving inventory? Additionally, outline a clear path for customers who do not pay within terms. How will your collection efforts escalate?
4) Structuring a Credit Application:
As a company, knowing what you need to know and how consistently and efficiently you can collect this information is key. Standard credit applications include basic firmographic information, management or ownership information, bank and trade references and submission of financial statements. It is increasingly important to understand the supplier relationships of your customer as well (e.g., are they heavily dependent on a single supplier for some reason).
5) Credit Line Determination:
What risk, operations and financial data elements will be considered when coming up with credit line assignments for individual customers.
a. Business Standing: At a minimum, years in business, ownership structure, legal name and Secretary of State filing information to ensure company is in active status and you’re selling to the correct legal name. Trade payment performance, Average High Credit (AHC), highest credit from peers, financials and public record information can also be very useful.
b. Trade: Credit line assignments may be set based on the individual order amount, high credit with your company, AHC using your company’s or your peers’ trade experiences with the customer, or based on an analysis of the financials. Some companies may incorporate these elements into a standard scoring model to facilitate credit line assignment.
c. Financials: Your company may decide that financial statements are required to extend some minimum threshold dollar figure. In those cases, credit line assignment may be based on some percentage of the working capital, tangible net worth or net profit of the company. Cash flow and leverage are also items to be considered.
6) Decision Authority:
Who has the authority to approve dollar credit recommendations? This may be based on position within the department or years with the company, possibly depending on the risk level and the size of the credit line. It also may be that certain dollar amount approvals may escalate to upper management, just as any credit extensions below a minimum level be handled through an auto-rating system.
7) Continuous Monitoring:
Once the credit line is set and credit has been extended, monitoring must be put into place. This ensures any deterioration in the financial condition or the payment performance of the company is noticed before it’s too late. Credit2B’s Chief Credit Officer Bob Carbonell emphasizes monitoring can be done by using an alert service offered by many credit reporting companies and by reviewing the customers’ credit line on a regular basis (yearly at a minimum). But, the most important alerts you can get would be though your peers that share a common information platform monitored for anti-trust. Put a regular review process into place to send emails out or put calls into those customers who need to update their credit application or provide updated financial information.
The most valuable tool to not only pinpoint changes in how a customer is paying, but also to determine if you’re being paid faster or slower than your peers across your entire portfolio. If you know your peers are being paid more quickly, you may be able to recover cash more quickly. Very few organizations evaluate their receivables consistently and with real automation, but the impact in dollars makes a much bigger difference on ROI than simply claiming to have the lowest write offs.
Any policy should be approved by upper management and then reviewed on an annual basis to be sure the policy is still in alignment with the company’s overall goals. A well prepared credit policy enables sales (as well as all functional partners) to have a clearer understanding of how strategies driving credit and collections complement their own respective objectives, in being part of the same working capital management process. The fast paced environment by which companies must compete and grow sales provides a challenge for various functional areas to remain focused and consistent in conducting its operations.
Credit2B’s goal is to empower accurate and timely business decisions by connecting you with every other organization that extends credit to your customers. Using patent-pending technology, Credit2B’s collaboration platform allows you to create connections with
trusted peers and securely control the exchange of data and experiences on common customers. Credit2B is remarkably simple to join; it’s easy to build your network and gain immediate access to relevant peer and public filing data. Contact us at firstname.lastname@example.org for more information.
About Bonnie Gerrity:
As the Vice President, Product, Bonnie manages a team that includes product management,
credit analysts, operations, and product operations. Bonnie was formerly a consultant in the commercial loan workout area, and credit officer with PNC/Midlantic Bank in charge of a team of 20 commercial credit analysts for loan package preparation. Earlier, she was Compliance Officer and Commercial Loan Officer for Midlantic Bank. Bonnie is a graduate of the University of Delaware, with a B.S. in Business.