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.
What is credit management?
Credit management refers to theprocess 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, andensuring 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: late payments by your customers have implications on your 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.
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.
What are the benefits of credit management?
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 riskand seize opportunities.
But that’s not all.The benefits of credit managementalso 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’s Days Sales Outstanding (DSO).
- Identifyingopportunities andfreeing up your company’s working capitalfor critical business investments that can support strategic growth.
- Helping youplan and analyse performance, which enables you to prepare financial budgets for the years to come.
- Reassuring potential lenderswho can fund your business expansion plans.
How to create a credit management strategy
Define your credit management process
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 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 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 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.
Establish client creditworthiness
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 paymentsby creating a proactive credit risk mitigation plan. This is an important step in credit and debt management.
Even existing customers should undergo aperiodic review 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 becauseit 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 TradeScore can help, as can trade credit insurance. They give you indirect access to financial information and help you with credit and debt management.
Supportcredit and debt management with documentation
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 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.
Monitor your client’s payment progress
Despite all these measures, unfortunately, you can’t guarantee your customers will pay their bills within the agreed-upon 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 insurance from Allianz Trade can supplement your customer credit management process and help protect against bad debts. Talk to one of our experts to learn how accounts receivable insurance can help your organisationprotect its assets and grow with confidence.
As an expert in credit management and debt mitigation, I bring a wealth of experience and knowledge to help you navigate the complex landscape of safeguarding your company from late payments and customer defaults. My expertise is rooted in a comprehensive understanding of credit management principles, risk assessment strategies, and proactive measures to ensure financial stability.
Now, let's delve into the key concepts mentioned in the article:
1. Credit Management:
- Definition: Credit management is the process of granting credit to customers, establishing payment terms, recovering payments, and ensuring compliance with the company's credit policy.
- Components: It involves granting credit, setting payment conditions, recovering payments, and ensuring overall adherence to the company's credit policy.
2. Importance of Credit Management:
- Significance: Late payments and defaults can lead to business bankruptcies, affecting the company's creditworthiness.
- Implications: Credit and debt management are crucial for running a business successfully, with implications on cash flow, liquidity, and overall financial health.
3. Benefits of Credit Management:
- Cash Flow Protection: Ensuring that cash inflows exceed outflows, allowing timely payment of bills and employee salaries.
- Reduction of Late Payments: Early detection and prevention of late payments, minimizing the risk of bad debts.
- Business Liquidity: Increasing available liquidity for operational needs.
- Faster Debt Recovery: Executing faster and more complete debt recovery.
- Days Sales Outstanding (DSO) Improvement: Enhancing the efficiency of collecting payments from customers.
- Strategic Planning: Identifying opportunities, freeing up working capital, and supporting strategic growth.
4. Creating a Credit Management Strategy:
- Process Evaluation: Assess current credit management services and practices within the company.
- Team and Rules: Determine who manages credit, evaluate payment terms, and establish rules linked to the late payment process.
- Industry Benchmarking: Compare average Days Sales Outstanding with industry standards.
- Supplier Payments: Adjust billing cycles and payment terms to align with cash flow.
- Diversification: Maintain a diversified customer portfolio to reduce reliance on a single customer.
5. Establishing Client Creditworthiness:
- Proactive Analysis: Understand clients' financial positions through proactive credit risk mitigation plans.
- Periodic Reviews: Regularly review existing customers to assess default risks.
- External Resources: Utilize Chambers of Commerce, credit bureaux, and references for up-to-date financial information.
- International Considerations: Assess international clients considering country-specific credit risks.
6. Support Credit Management with Documentation:
- Contract Conditions: Ensure contracts include delivery and payment conditions, and seek legal review.
- Clarity in Procedures: Clarify payment procedures, policies, and invoicing details.
- Invoice Optimization: Include essential details on invoices to maximize the chance of on-time payments.
7. Monitoring Payment Progress:
- Customer Monitoring: Regularly review customer payment progress aligned with perceived risk.
- Communication: Communicate with customers about late payments before resorting to legal actions.
- Professional Intervention: Consider professional debt collectors or credit management services for persistent late payments.
8. Additional Credit Management Services:
- Trade Credit Insurance: Utilize services like Allianz Trade TradeScore or trade credit insurance for added protection against bad debts.
By integrating these concepts into a well-defined credit management strategy, your company can not only mitigate risks but also foster sustainable growth and financial resilience.