Blog · Approx. 8 minute read
What Is Credit Management? (& Why It Matters)
Benjamin Franklin once wrote:
Remember, that money is of the prolific, generating nature. Money can beget money, and its offspring can beget more, and so on …. The more there is of it, the more it produces every turning, so that the profits rise quicker and quicker.Benjamin Franklin, Advice to a Young Tradesman, Written by an Old One (1748)
This still holds true today, nearly 300 years later.
Many businesses struggle with managing credit and think it’s because they are too busy with their core work.
However, credit management can heavily influence their overall business performance, so it should also be considered a part of it.
Let’s take a look at what credit management is, why it matters and how you can improve it.
What is credit management?
Credit management is everything directly related to the processes of approving customers for onboarding, extending payment terms, setting credit and payments policy, issuing credit or financing and monitoring business cash flow.
It is practiced by banks and businesses across all industries and markets. Best practices, levels of risk and days sales outstanding (DSO) vary in each of these.
(This latter term – DSO – means the average time period. It is usually measured in how many working days it takes between a sale being made and the payment for that sale being received or collected.)
At its core, credit management is the caretaking of your company’s financial health. Good credit management can make the difference between a company surviving, thriving or going bankrupt.
Is credit management the same as collections?
Credit management and collections are not the same things. However, they are closely related to one another and are often managed by the same department.
In some cases, companies may control their own credit management but outsource their collection process.
This could be because they haven’t got the resources to focus on both, or because they believe a professional collections service is simply better at recovering their invoices and debts.
Some companies even find that third parties collections agencies automatically induce quicker payments. This is because companies worry that late payments to them might affect their credit rating.
Both credit management and collections fit part of the wider order-to-cash (O2C) process.
This term covers everything from when the customer orders to when your business receives the cash, i.e., receiving orders, shipping products, invoice issuing, collections, and creating a record of sales.
The main components of credit management
Below is our list of the most important areas involved in good credit management.
1. Assessing and approving new clients
A good credit management system can quickly and effectively assess a customer’s financial situation.
Balancing these two competing requirements isn’t easy.
Overly long assessment processes risk potential customers abandoning the process and going to your competitors. And if assessment isn’t done to a high enough standard, your business might be taking on risk.
2. Setting payment terms
Setting payment terms is the practice of deciding when invoices should be paid.
Companies often need to strike a balance between offering terms suitable for their industry and the cash flow issues and risks that longer terms bring.
Companies often need to strike a balance between offering terms suitable for their industry and maintaining a healthy cash flow issues and low risk profile.
In other words, providing longer payment terms can increase your customer base, but it might also increase your risk and reduce your cashflow.
What is a credit policy?
Acredit policy is a set of guidelines and rules that guide credit management operations.
It lists rules around payment terms, late fees, credit limits, payment terms, interest rates, and more.
A good credit policy should do the following:
- Define customer’s credit limits (this is maximum amount they can borrow)
- Define credit terms (when payments, discounts, and late fees are due)
- Where to record transactions
- What actions to take collections and for non-payment
A good credit policy should be kept-up-to date and reviewed per
3. Extending credit to existing customers
Extending credit covers multiple scenarios, including issuing credit notes and offering financing options to your customers.
It is often necessary if you want to retain business. And financing can bring extra benefits such as higher sales volumes and customer loyalty.
Credit terms can vary according to the credit or payment history of specific customers. Credit management decisions are critical when considering offering these financial services.
4. Tracking customer credit
An important function of credit management is the ability to monitor and prioritize your sales ledger.
This area may crossover into the realm of collections. For example, for B2B companies, it might involve dunning, which is an important part of establishing the status of late payments.
What is a credit manager?
A credit manager is someone responsible for overseeing the credit management process.
Credit managers usually have backgrounds in finance and/or business administration. They manage the assessment of multiple potential and existing customers simultaneously.
The role requires good analytical and communication skills. These abilities are essential to a company’s economic performance.
What is good credit management?
Simply put, good credit management involves ensuring all customers paying their invoices on time, within the terms and conditions.
That’s the ideal. In reality, it’s very unlikely all customers will pay all outstanding invoices in full and on time. This is why you need a good credit management program and team.
Credit managers should have oversight over the credit management process and best practices. They should also be responsible for keeping your credit policy up-to-date.
The benefits of good credit management
Credit management is important because it reinforces a company’s liquidity. If done correctly it will improve cash flow and lower the rate of late payments.
It’s the difference between a high or low DSO, amount of bad debt a financial portfolio presents and even negative or positive customer relations.
B2B credit management
Business-to-business (B2B) credit management is simply credit management carried out by most businesses that work primarily with other businesses.
The categories of B2B and business-to-consumer (B2C) are useful. The highlight important differences between working with other businesses and consumers.
For example, B2B order volumes are usually higher but less frequent than B2C ones. This effects the customers’ payment terms which effects the suppliers’ cashflow.
There are also other things to asses and monitor, such as your customer’s customers financial situations.
4 Questions to evaluate your credit management process
We’ve pulled together a few questions to help determine the quality of your current credit management.
1. How are you evaluating customer credit?
When new customers apply for credit, you’ll need a system, manual or automated, to determine creditworthiness. Then a process in place to monitor it over time.
2. What is your invoicing process like?
This can also be manual or automated, paper or electronic. It’s important to keep in mind, nearly 1/3 of B2B organizations report that over 50% of their customers have unique invoice requirements.
3. Who handles the collections?
It’s inevitable that customers will fall behind on payments. You’ll need staff to track down payments and apply them correctly.
It takes on average more than 18 hours per week for a full-time employee to collect payments and more than four days to onboard new customers.
4. What is the role of your employees in this issue?
Reliance on manual A/R processes takes a human toll.
A/R teams struggle to keep up with the high volume of customer requests and disputes as well as the increasing amount of invoice and billing errors that require attention.
Do you need a third-party credit management partner?
If the above tasks are not within your core competencies, it’s time to consider credit management support.
Each question is interlinked and can be outsourced, or even automated in some cases, with an accounts receivable partner such as TreviPay.
Choosing a Credit Management Provider
Once you’ve decided to seek a third party to help manage your credit program, look for a provider with a comprehensive service and platform.
It’s also important to find a partner who knows your industry well and can quickly analyze and improve your risk exposure.
TreviPay’s solution extends risk-free credit and automates A/R under your brand while providing protections against bad debt. We handle everything from underwriting the credit, onboarding and invoicing through to collections and more.
Good credit management is essential to maintaining or growing a sustainable business.
It is often associated with the collections process. They are linked and often take place in the same department but they are not the exact same thing.
Credit managers need to make quick but thorough assessments about onboarding new clients and extending credit. They also need to balance reducing risk with maintaining or increasing cash flow.
Business-to-business (B2B) credit management is often more complex than business-to-customer (B2C). It involves high order volumes and longer payment terms.
There are several ways you can evaluate your current credit management. These include following best practices for assessing customer credit, invoicing, collections and employee allocation.
In some cases, outsourcing your credit management to a third party can help you improve cash flow and better utilize internal resources.
Schedule a demo today to see first-hand how TreviPay can help your business grow.