September 03, 2021

Credit Management Excellence: What Does It Look Like?

6-minute read

What Is the Credit Management Process?

Credit management is the process a company uses to extend credit to its customers for the purchase of goods and services. It is a vital process that supports many aspects of your business, and it involves much more than just the simple extension of credit lines.

The credit management process is important for any business. Poor credit management can negatively impact your cash flow, tarnish your reputation, and erode trust with your customers.

As an accountant, you are responsible for managing your company’s balance sheet, including cash, receivables, and inventory. If your organization has many poor-performing or delinquent accounts that need more attention than usual, it may be time to take a closer look at the credit management process.

How to Establish a Credit Policy

Your company’s credit policy will ensure consistency by providing guidance to your customers and your employees for how credit is to be extended and managed. It will contain several elements, including the following:

  • Reliable criteria for evaluating a customer’s creditworthiness
  • Limits for how much credit can be extended
  • Defined terms for how credit is to be repaid, including penalties and interest that will accrue on unpaid balances

What Are the Usual Steps in Credit Management?

To build and maintain effective credit management, certain steps are essential. You will want to develop a set of policies that clearly outline the terms of credit for customers of your business, such as the level of credit that may be extended, terms of payment, interest, what constitutes default, and how the policies will be enforced.

With such guidelines in place, your credit or AR manager can determine a customer’s credit rating before credit is extended. The credit eligibility process should be thorough and detailed, covering all the necessary information, including financial statements and credit history to establish the customer’s ability to pay the debt that has been incurred.

Once credit is extended, it’s important to have a consistent and effective process in place for regularly monitoring customers to see if any new risks emerge. This will include invoicing, collection, and follow up to ensure regular and reliable payments that sustain a healthy cash flow. 

In particular, monitor a customer’s payment history and look for patterns of missed payments. If, for example, a customer has missed a payment for the first time, this calls for a different response than if there is a longer history of missing or late payments. The response will vary in severity depending on how serious the problem has become.

Credit is based on trust, and a good credit management process will include good customer relations. Be proactive by identifying and responding appropriately to late payments and complaints early on. Have a policy for collecting overdue payments. Be flexible but firm in managing those situations. Do not make allowances that leave the business at undue risk for the collection of outstanding debt.

How Is Credit Management Calculated?

A number of factors can be taken into consideration when calculating the terms of credit extended to a customer. These will determine the degree of risk the company is prepared to expose itself to as well as the customer’s ability to repay.

The customer’s creditworthiness will tell you how much risk your business will expose itself to, and much of the information about the customer will be provided by the credit reporting agencies. Payment performance, financial statements, and purchase patterns will come into consideration.

The business extending credit should also consider both the strength of the product or service being sold and the financial strength of the customer. The value of the product in the market—including price, sales volume, and demand—can give you an indication of how much credit should be extended with a reasonable expectation of payment obligations fulfilled.   

There will be some customers who ask for an extension or adjustment in the credit that has already been given to them. Doing so has risks and rewards. Extending credit builds goodwill with your customers and shows that you are a financially healthy organization that can afford to extend credit.

On the other hand, your business exposes itself to greater risk if customers are unreliable. Extended credit can also have a negative impact on cash flow or Days Sales Outstanding (DSO), which is a measure of the average number of days it takes a company to collect payment for a sale. 

How Is Credit Management Traditionally Executed in the B2B World?

In a time before digital technology, B2B credit typically relied on spreadsheets. This was combined with the dunning process, which involved manually reaching out to customers to collect accounts receivables.  

This entailed sorting through data from multiple systems to fully understand a debtor’s situation. With this information in hand (literally, in some cases), credit professionals typically work through their debtors, starting with the customers that have the greatest overdue debt. 

Conclusion

Today’s companies have the aide of artificial intelligence (AI) to digitize credit management, and the dunning process can now be largely automated. AI-driven solutions eliminate the low-value manual tasks that consume so much of the typical credit professional’s day.

Workflows are digitized and customized for each customer. Statements and overdue letters are generated and delivered electronically based on intelligent profiling.

Customer calls are automatically prioritized based on historical data and information from third-party agencies and others. Credit professionals are alerted when action is required or when a payment trend changes.

Data analysis also aides the credit management process. Machine learning (ML), a form of AI, has the ability to analyze unstructured data and perform modeling functions that help companies identify early warning signs to help reduce risk.

AI-driven solutions allow credit managers to automate various aspects of the credit management process, up to and including important decisions like credit limits. 

In short, implementing digital decision-making in your credit management process will help your business in a number of ways. It will allow you to simplify processes, eliminate opportunities for errors, and speed cycle times. All of this will save you time, reduce risk, and free up staff to perform other important functions for your business. 

Discover how your F&A organization can reduce manual activity by as much as 85% and collect more cash using AI automation.

Michael Shultz

Modern Accounting