Protecting your company from late payments and customer defaults is essential. To do so, you should ensure you have an effective credit management policy in place. But what is credit management and what are its benefits? In this article, we take you through credit management step-by-step, from strategy to execution.
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 that one in five business bankruptcies amongsmall to medium companies occurs because customers default on their invoices.And that’s the knock-on effect: late payments by 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 as your company’s action plan to guard against late payments or defaults by 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.
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 payments by detecting them earlier and preventing bad debts, consequently reducing the possibility that a default will adversely impact your business.
- Increasing available business liquidity.
- Executing faster and more complete debt recovery.
- Improving your company’s Days Sales Outstanding (DSO).
- Identifyingopportunities and freeing up your company’s working capital for critical business investments that can support strategic growth.
- Helping you plan and analyse performance, which enables you to prepare financial budgets for the years to come.
- Reassuring potential lenders who 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 place linked 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 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 optimising contract management and accounts receivable collections, identifying and analysing 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 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 analyse their risk of defaulting on payments by creating a proactive credit risk mitigation plan. This is an important step in credit and debt management.
Even existing customers should undergo a periodic reviews process. Just because you have a good relationship with a customer doesn’t meanthey are impervious to default.
Chambers of Commerce and credit bureaux, 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 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.
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. A customer credit vetting tool like Allianz Trade TradeScorecan help, as can trade credit insurance. They give you indirect access to financial information and help you with credit and debt management.
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 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 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 maximise 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 of late 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 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.
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 how accounts receivable insurance can help your organizationprotect its assets and grow with confidence.
As a seasoned expert in credit management, I can attest to the critical role it plays in safeguarding a company from late payments and defaults. The article you provided covers key concepts and practices related to credit management, emphasizing its importance in maintaining financial health and mitigating risks. Let's delve into the essential points outlined in the article:
1. Definition of Credit Management:
Credit management involves the strategic process of granting credit to customers, establishing payment terms, recovering payments, and ensuring compliance with the company's credit policy. It serves as an action plan to guard against late payments and defaults, with a continuous and proactive approach to identifying and mitigating risks.
2. Benefits of Credit Management:
The article highlights several benefits, including:
- Cash Flow Protection: Ensuring positive cash inflows to meet financial obligations.
- Reducing Late Payments: Early detection and prevention of late payments to minimize bad debts.
- Business Liquidity: Increasing available liquidity for operational needs.
- Debt Recovery: Executing faster and more complete debt recovery.
- Days Sales Outstanding (DSO) Improvement: Enhancing the efficiency of collecting payments.
- Opportunity Identification: Identifying opportunities and optimizing working capital for strategic growth.
- Financial Planning: Facilitating performance analysis and financial budgeting.
- Lender Confidence: Providing reassurance to potential lenders for business expansion plans.
3. Credit Management Practices:
The article suggests evaluating current credit management practices within a company. Key considerations include:
- Responsibility: Identifying who manages credit—whether a team, individual, or busy executives.
- Payment Terms and Rules: Establishing clear payment terms and rules linked to the late payment process.
- Credit Risk Management Best Practices: Implementing best practices, including optimizing contract management and accounts receivable collections.
- Diversification: Maintaining a diversified customer portfolio to avoid reliance on a single customer.
4. Proactive Approach:
Being proactive is crucial in credit management, involving:
- Client Financial Analysis: Understanding clients' financial situations, including new and existing customers.
- Periodic Reviews: Conducting periodic reviews even with established relationships.
- International Credit Management: Recognizing complexities in managing credit with foreign customers, considering country-specific risks.
5. Contractual Considerations:
When establishing contracts with customers, the article advises on key tips:
- Clear Conditions: Including delivery and payment conditions in the contract.
- Legal Review: Involving a lawyer to review contract conditions.
- Invoice Procedures: Clarifying payment procedures, policies, and invoicing details.
- Timely Invoicing: Invoicing promptly upon completion of work or service provision.
6. Dealing with Late Payments:
The article recommends a measured approach to late payments, including customer communication, written reminders, and involvement of professional debt collectors when necessary.
7. Supplemental Credit Management Services:
In addition to a well-defined credit management strategy, the article suggests considering supplemental services like trade credit insurance to protect against bad debts.
In conclusion, a comprehensive credit management strategy is indispensable for the financial well-being of a company, encompassing various elements from risk assessment to proactive customer management and contractual considerations. If you have any specific questions or require further insights on a particular aspect, feel free to ask.