What Is Credit Management and What Are Its Benefits? - Controllers Council (2024)

Credit management refers to the process of granting credit to your customers,setting payment termsand 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.

We estimate thatone in five business bankruptcies amongsmall to medium companies occurs because customers default on their invoices.And that’s the knock-on effect:By havinglate payments, your customers, have implications on your own creditworthiness. That’s why credit and debt management are essential to running your business successfully.

So when wondering ‘what is credit management?’ think of it asyour company’s action plan to guard against late payments or defaultsby your customers.

An effective credit management uses a continuous, proactive process of identifying risks, evaluating their potential for loss and strategically guarding against the inherent risks of extending credit.

One of the key benefits of credit management is the ability to see a clear picture of your company’s finances, so you can avoid unnecessarycredit risk and seize opportunities.

But that’s not all.The benefits of credit management also include:

• Cash flow protection: ensuring that your cash inflows are always higher than your cash outflows so that you can pay your bills and employees on time.
• Reducing the number of late paymentsby detecting them earlier and preventing bad debts, consequently reducing the possibility that a default will adversely impact your business.
• Increasing availablebusiness liquidity.
• Executing faster and more complete debt recovery.
• Improving your company’sDays Sales Outstanding (DSO).
  
• Identifyingopportunities andfreeing up your company’sworking capitalfor critical business investments that can support strategic growth.
• Helping youplan and analyze performance, which enables you to prepare financial budgets for the years to come.
• Reassuring potential lenderswho can fund your business expansion plans.

First, take a close look at the credit management services and practices currently employed by your company:

• Who is in charge of managing credit:A team? An individual? Or busy executives who may not have the time to make accurate credit decisions?
• What are the rules in placelinked to payment terms or to your late payment process?

If you don’t have a credit and debt management process in place yet, here 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 toadjust your billing cycle and payment terms.
• Maintain a healthy diversification in your customer portfolioso that you’re not relying on one big customer.

The whole company should become familiar with,which includeoptimizing contract managementand accounts receivable collections, identifying and analyzing the risk of new clients defaulting on payments and creating aproactive credit risk mitigationplan. You should define the actions you require in credit account management from other departments and make peopleaccountable.

Finally, your credit management process should seek a healthy balance between avoiding risk and seizing 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.

Being proactive plays an important role in managing credit – in particular, understanding your clients’ 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 paymentsby creating a proactive credit risk mitigation plan. This is an important step in credit and debt management.

Even existing customers should undergo aperiodic reviews process. Just because you have a good relationship with a customer doesn’t meanthey are impervious to default.

Chambers of Commerce and credit bureau, bank and trade references, etc. can reveal a customer’s most up-to-date financial activities, as well as their cash flow status.

So take a look at the customer’s specific industry and market and note the comparison with the economic performance of closely-related industries.

Managing credit becomes more complex when conducting business with foreign customers becauseit can be difficult to interpret and understand information used by foreign countries to measurecreditworthiness.

When assessing an international client,include,country specific credit riskssuch as fluctuations in currency exchange rates, economic or political instability, the potential for trade sanctions or embargoes, etc.

Overall, audited financial statements are the best way to understand a company’s financial picture, though some privately held customers may not be willing to share these with you.

When establishing a contract with a customer, here are a few tips you should keep in mind:

• Ensure the contract includes your delivery and payment conditions and explains any provisions in the agreement, such as which conditions apply and are acceptable to you.
• Ask a lawyer to review the conditionsupon entering into the contract.
• Clarify your clients’payment procedures, policies and idiosyncrasies and identify to whom you should send your invoices and ask for acknowledgement 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, printed on the back of the invoice.

Thanks to these simple credit and debt management tips, you should find a reduction in the probability oflate or non-payments.

Despite all these measures, unfortunately, you can’t guarantee your customers will pay their bills within the agreed-upon time period. This is where your credit management policyand credit management services prove essential again. Monitoring your customers’ payment progress to make sure they’re complying with your contract agreement can help avoid unpleasant surprises.Review each customer with afrequency that aligns with the perceived riskthat 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 reminderthat 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.Trade Credit Insurancefrom Allianz Trade can supplement your customer credit management process and help protect against bad debts.Talk to one of our local experts to learn howaccounts receivable insurancecan help your organizationprotect its assets and grow with confidence.