What is credit management? What does a credit manager do? Look no further, this article will guide you through the credit management process step-by-step!
October 31, 2022 
Credit management can be defined as a firm’s detailed plan to minimise the frequency of encountering past-due invoices and defaults by its customers.
Proper credit management can make a drastic difference in whether a firm will be able to survive or not.
An excellent credit management system employs a proactive procedure of recognising risks, determining their likelihood to occur, and devising strategies to lower the probability of each risk happening.
Credit management is performed by corporations and banks alike across every industry vertical and sector. However, the best practices, risk tolerance, and key performance metrics (KPIs) will differ in each of these.
Defending a company against issues such as customer defaults and late payments is vital. Therefore, establishing an adequate credit management system in place should not be a process overlooked by business owners.
To help businesses achieve that goal, Kolleno is a smart credit control platform empowering finance professionals with its accounts receivable software to ensure that their credit management system adheres to the world-class standard.
Simply put, credit management is the practice of investigating, evaluating, and establishing the terms and conditions for a company to authorise requests for credit made by its customers or clients.
In business-to-business (B2B) commerce, it is relatively common for companies to issue credit during the sales of their products and/or services to their customers. However, this comes with the expectation that these customers will settle their invoices punctually as initially aligned. Nevertheless, it remains imperative for corporations to assess whether the client’s company can be permitted to purchase the offering on credit and determine the size of the credit to be granted.
With that, credit managers would usually be the key personnel designated to address these questions. Their goal would be to facilitate sales whilst lowering the company’s exposure to risk (e.g., bad debt).
In short, credit management and collections refer to two different things. Nonetheless, they are closely related to each other and are usually handled by the same department within a corporation.
However, some firms may prefer to oversee their credit management unit and outsource their collection procedure. Some of the potential reasons for this arrangement is that the company does not possess sufficient human resources and/or resources to work on both. Alternatively, it could be due to the firm’s management believing that hiring a professional collections agency would be a more practical strategy to recuperate their unsettled debts and invoices.
Approximately one in five bankruptcy cases amongst small- to medium-sized enterprises (SMEs) were caused by the high number of clients defaulting on their invoices. Such a phenomenon, in turn, has a domino effect on the company as unpaid invoices can significantly affect the SMEs’ creditworthiness. With that, this showcases the importance of ensuring that a proper credit management system has been set in place to protect the company from such events.
Besides that, another notable advantage of having a credit management protocol is that it allows the company to obtain a high-level, big-picture overview of the firm’s financial health. This consequently assists the management in their cash flow protection, in which they would be able to make sure that the overall cash inflows consistently exceed the company’s cash outflows. Meanwhile, such practices also permit the firm to reduce the frequency of late payments or defaults as it can identify and segment clients on their credit histories.
With these improvements, the company would eventually improve its number of days sales outstanding (DSO) metric, which is vital in reassuring the shareholders’ confidence in the management team’s competency. Not to mention, these credit management effects may also free up the firm’s working capital to be spent on strategic corporate investments that may boost the business’s future performance. Furthermore, companies would also have additional sets of data to analyse their productivity, which is a valuable guide during the financial budgeting process for the upcoming financial years.
During a B2B sales transaction, there are a number of crucial elements within the credit management process, beginning with:
Essentially, an effective credit management system will enable finance professionals to quickly and accurately determine the financial state of their clients. Though managing the client during this step is highly critical and requires a great deal of relationship management skills. Much of this is because the business may risk losing its prospective client if the due diligence procedure becomes overly time-consuming. However, on the other hand, if this step has not been correctly executed, the company will face a risk of taking on bad debts. Thus, striking a delicate balance between these two criteria is vital.
Simply put, this is the step whereby the management team will need to determine the length of the credit period and when the invoices have to be settled. Similar to the previous step, this would necessitate the firm to find a healthy balance between the provision of terms that adhere to the industry norms as well as the offering of a term that does not cost the company cash flow issues and risks of default in the future.
This step is usually a necessity if the company intends to maintain a long-lasting professional relationship with their customer. Still, multiple aspects encompass the credit extension process, including the issuance of credit notes alongside the provision of financing options to the company’s clientele.
In particular, the offering of financing options may bring in additional returns, such as increased customer stickiness and/or more significant sales revenue. Meanwhile, the particular credit terms could differ based on the customers’ respective payment and credit histories. Thus, the employees managing this step of the credit management process will need to possess a sound judgement of their customer’s creditworthiness before finalising the terms.
Once the credit terms have been fully extended, the following critical function of the credit management team is to track and prioritise the company’s sales ledger continuously.
This is where the credit management process might cross paths with collections. For instance, should the procedure involve the issuance of dunning letters, this signals the emergence of late payments amongst the client base and, thereby, a flaw within the credit management system.
In most circumstances, credit managers would investigate data points obtained from a myriad of sources before making an educated decision on the proposed credit terms for their client. Such information sources may include the prospective customers’ banks, trade references, or credit bureaus.
During the analysis stage, credit managers may evaluate the viability of the prospective client’s business model, which has long-term implications for their customers’ ability to settle their invoices upon their payment due date. Other than that, the analysis could also revolve around a study of the company’s internal outlay of credit, whereby credit managers must be extremely mindful of their firm’s overall exposure to potential cash flow shortages prior to issuing credit terms.
Overall, the best credit managers are well-equipped with a mixture of hard and soft skills, solid analytical capabilities, a sound background in statistics, and a strong ability to make logical decisions that have the company’s bottom line in mind.
On top of that, successful credit managers will also need to master a number of other skills, which could be considered a non-negotiable depending on the company’s culture. Examples of such skills would include:
Although their job titles may not necessarily be indicative of such, credit managers and collections agents are in a customer-facing role as they will need to provide help to their current and prospective clients. Hence, credit managers need to develop their interpersonal skills and build positive relationships with their clients to safeguard a long-lasting business relationship.
Put simply, effective communication skills are a must-have for all credit managers as this skill can impact the success rate of payment collections, the quality of their customer services, together with their decision-making capabilities. Therefore, it is critical for credit managers to possess a clear and direct communication style to prevent any form of miscommunication from occurring, especially during such an important task.
Given that credit managers will need to strike a delicate balance between being customer-centric whilst also having the company’s best interest at heart, it comes without any surprise that the best credit managers will be required to possess strong negotiation skills. All in all, such capabilities will be crucial to help credit managers devise solutions that ensure a win-win situation for both the internal and external stakeholders during the credit management process.
Although the majority of firms would have an in-house legal counsel, credit managers with a working knowledge and sound understanding of the local, state, and federal laws will have an added advantage. This is because these credit managers would be able to avoid the accidental creation of liabilities for the business. Nevertheless, if the credit manager has any unaddressed legal queries, they will be strongly advised to immediately consult the internal legal team before proceeding with any decision.
Developing and implementing a successful credit management process involves a number of steps. This often starts with the proper definition of the credit management protocol.
Firstly, the management will need to investigate the current credit management policies and practices adopted by employees and familiarise themselves with the roles and responsibilities of every person involved. This, in turn, can help the company pinpoint potential weaknesses in their existing system and thereby suggest the appropriate improvements to rectify the identified problems.
However, if a company does not have a credit management system in place yet, there are a number of components worth considering:
-Determine the firm’s average number of days sales outstanding (DSO), which is the mean number of days the company takes to collect their clients’ payments. The calculated figure should then be compared to the industry’s DSO.
-Investigate if the company has been able to pay suppliers prior to the incoming customer payments. If this is indeed the case, the business might need to consider adjusting its credit terms and period as well as the billing cycle.
-Diversify the client portfolio in order to protect the company from being overly dependent on a single customer to support its cash flow.
-Take the initiative to ensure that all employees are well-informed about the company’s credit management procedure alongside the best practices. Additionally, the management team ought to also hold the key employees accountable for their roles and responsibilities in the credit management procedure.
There are a few important questions that companies should address whenever they are assessing the efficacy of their credit management system:
1. How is the company evaluating the clients’ creditworthiness?
2. What does the firm’s invoice management process look like?
3. What are the typical credit terms and conditions that get extended to the clients?
4. What are the roles and responsibilities of the credit management team?
5. Who is the key employee responsible for overseeing the credit management process?
Overall, the credit management procedure is mainly manual, time-consuming, and extremely labour-intensive work.
On top of that, the credit management team is usually faced with two opposing sources of pressure. On the one hand, they are expected to formulate a decision quickly for the company to finalise the sales transaction process sooner and proceed with the next customer. On the other hand, however, the credit management unit needs to obtain sufficient data and information to make a well-educated decision as part of protecting their firm from incurring bad debts.
Nonetheless, the decision-making step within the credit management process can be accelerated via the adoption of technology that can automate the accounts receivable and collections management procedure.
In particular, such technological solutions may be seamlessly onboarded via two approaches:
The collection of information regarding a prospective customer’s credit application history is notorious for its slow pace, which involves manually gathering bank reference documents, trade references, and credit bureau reports. To make matters worse, this procedure typically requires credit managers to manage and coordinate the work of several stakeholders simultaneously.
On that note, automation technology can significantly lower the onboarding timeline (from weeks to days) as it dramatically simplifies the document collection process.
Kolleno serves as a great example of such technology, whereby it is a smart credit control platform equipped with a collections solution and accounts receivable software to help businesses streamline their credit controls.
The applications of artificial intelligence (AI) can come in many forms, including the production of a business viability score or even the prediction of a client’s likelihood of defaulting on their payment. What’s more, these digital tools would be able to predict the customers’ creditworthiness at a faster speed and much more accurately compared to human credit managers.
In a nutshell, employing a proper credit management process is a necessary step to sustain and grow a company. Therefore, the credit manager bears the duty of performing fast but thorough due diligence on their clients during the early sales stages while also balancing the plausible risks associated with the transaction.
Though in most situations, investing in digital tools to automate the entire credit management protocol may elevate a business’ ability to improve its cash flow and optimise for the efficient use of internal resources in the long run. With that, Kolleno offers a number of solutions tailored to every company’s finance and credit control needs because its platform has various functions ranging from automated collections strategies to accounts receivable analytics tools.
Credit management is the process behind developing and implementing credit and payment policies, permitting clients to be onboarded, extending credit terms, as well as tracking the company’s cash flow state. This procedure has been widely adopted by corporations and banks across all sectors, although their risk appetite and best practices may differ substantially.
As credit management is all about awarding credit terms and ensuring that the money can be collected upon the client’s payment due date, establishing a proper protocol to govern this process simulates communications between the sales and finance departments. Consequently, such practices can help to generate a balancing act between maximising business development opportunities and the minimisation of risks.
In essence, an effective credit management process seeks to develop close-knit and trusting relationships between the company and its clients as part of ensuring that profitability is achieved during the entirety of their engagement. With that, three key goals of credit management are safeguarding the company from the customers’ risk of default, enhancing the firm’s cash flow health, and settling any outstanding payments as early as possible.
