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Credit Management policy

What is a credit management policy?

This is an operational document defining a number of operating rules for the sales process that must be followed by the entire company including of course the credit team.

It defines the standard conditions of sale (standard payment terms, early payment discount rate... etc.) and the processes to apply the rules (how to open an account, how to set a credit limit, how to recover the bills ...etc.).
Credit management policy

These rules are intended to do "good" sales and to converge business strategy, commercial stakes and financial issues (credit risk, cash, profitability, working capital improvement).

Why implement a credit management policy?

The establishment of a procedure for credit management is necessary and critical in business since the number of employees exceeds ten and unwritten rules that are no longer appropriate. It defines the rules of operation at each stage of the sales process and clarifies the responsibilities in line with the business strategy.

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Thus, it limits the internal conflicts that inevitably appear when the personal interests of the people involved differ. For example, it is common that the commercial, focused by the sale, cares little for the solvency of its potential buyer. However, an accountant or financial manager care more of the cash position and the risk to grant a credit to an insolvent client.

The policy of credit management clarifies the objectives of the company and set best practices that must be followed by the entire organization.

Credit management strategy
Key factor of success, it must be shared between vendors, business management and finance department. It is a document which specifies operating "standard" modes for all stakeholders while providing rules for exceptions.

Indeed, the principle of the trade is to be specific to a business relationship to another, from an economic context to another. Each company must be able to adapt its offer to it and sometimes depart from the rules of running operations it has set itself.
The credit policy does not include irremovable rules. It is not a static document for financial controller which gathering dust in a corner office. This is an operational document which sets operating modes in accordance with the interests of the company whose ultimate goal is to be paid by its customers.
The division of tasks between employees can generate antagonists interests, as may be the case between finance and sales department. But the supreme interest of the company must prevail. This is the role of the procedure for credit management. It reconciles interests by setting limits to each of them and providing for arbitration in specific cases.

Operating rules established by the procedure may in some cases be overridden but within a framework defined in advance. Thus, it includes a chart of authority which determines for each decision committing an additional risk to the company the power of validation of each actor. For example, sending a new order for a customer who is in default of payment for more than 30 days may be subject to the validation of the CFO.
In addition to clarifying responsibilities, adherence to such a procedure is used to circulate information in the vertically (hierarchically subordinate) and horizontally (across multiple services).
It promotes communication and mutual understanding of the different stakeholders. It therefore avoids the "silos" generated by the withdrawal of each service who does not understand the attitude of other services.
Finance and commerce are not intended to quarrel but to understand each other because everyone has a share of the primary interest of the company.

Of course a company must sell and develop its sales, obviously it must ensure its sustainability by avoiding overdue and bad debts. These issues are not exclusive, quite the contrary. This is what helps the establishment of a procedure of credit.

Which the rules for which processes?

The purpose of the credit management policy is to define rules on all steps that are likely to generate business risk by committing financial resources. This is done in order to manage this risk and to minimize them.

Well managed, a risk can become an opportunity. For example, if you have evaluated a customer as insolvent, you can request a payment in advance against an interesting discount. This helps to improve cash flow of the business while avoiding any credit risk.

Main stages of the sales process

Timing diagram of the sales process:

Sales process

1) commercial prospection

Business development incurs costs and should be well oriented to be effective. It is for example against-productive to spend time and money to win an order with an insolvent potential client:
  • The financial position of the buyer intends more to regression or disappearance through a bankruptcy rather than becoming a key player in the market,
  • Win a business with this company will result in payment delays or even unpaid invoices and losses,
It is therefore essential to take into account the financial situation of companies before prospecting them. Better canvass companies in good financial health and with good potential.

2) Quotations

These deals can be engaging for the seller, it is necessary to include commercial conditions (conditions and mean of payment, guarantees... etc) coherent with the context and the creditworthiness of the buyer. Credit risk starts at this stage. It is therefore necessary to define how it is assessed (financial analysis, credit rating etc ...) and how it is managed.

3) Customer account opening

The customer opening account must follow certain basic rules to obtain necessary information in order the administrative flows are fluid and do not disrupt the business relationship. Defined rules specify what documents / information to be obtained prior to account opening and who must obtain them.

4) Payment terms and credit limit set up

This stage occurs during the trade negotiations and may be before or after the opening of account. It is here that are approved payment terms (payments, deferred payment, method of payment, invoicing schedule ... etc), and any guarantees (bank guarantees, parent company guarantees, delegation of payment, documentary credit ... etc.. ).

This is the heart of the prevention of outstanding risk. These conditions should be an integral part of commercial negotiations and result from risk analysis that was done previously. The credit management process defines the standard conditions, checks if it is possible to grant them to the client and manage any deviations from this rules.

5) Delivery and invoicing

This step should not be overlooked as it is often a source of disputes that generate late payment and have negative impacts on the business relationship. The credit management process specifies the prerequisites for billing in a timely manner and the key steps to check to do a good billing and not make errors (price, date of invoice, customer name, etc ...).

6) Friendly collection

Essential phase not to suffer late payments, the cash collection should be structured and professionalized to be effective. Well done, debt collection lends credibility to the seller, significantly improves cash flow and contributes positively to build a commercial relationship.

The recovery process must be defined in a combined result of recovery actions (phone calls, email, mail return receipt, intervention of the sales representative ... etc) and agreed between the recovery service or accounting and sales managers.

It also specifies how are used late payment penalties to get customers to pay in a timely manner.

7) Litigation

In case of failure of amicable collection that ended with sending a letter of formal notice, collection action continues but with other means. These are numerous and depend on the organization of each company and its customer types:

  • Lawsuits handled by the seller with the contribution of a lawyer (referred provision, payment order or assignment payment),
  • Collection agencies,
  • Bailiffs,
  • Credit insurers.

Conclusion

The credit management policy includes all the steps above, describes how they are implemented and by whom. It must be operational and concrete and therefore be adapted to each company. There should not be two identical procedures as each business is unique and has its own strategy.

It represents the application in practice of a business strategy and management of customer credit defined by the direction of the company. It allows to structure the business, improve performance and relationships between the different services that compose it.

In a complex and difficult economic context, the implementation of such rules gives a direction to the company and its employees and helps protect as much as possible his company from overdue and losses, responsible of a business failure on 4 and many broken dreams of entrepreneurs.

Well established and applied it will help to improve cash flow and working capital needs of the company and to preserve its future and fostering its development.

Tools download:

The chart of authority is an approval matrix defining the approbation level needed to set credit limits and payment conditions.

It is a key tool which has to be part of the credit management policy.
Template of credit management procedure including all steps of the quote to cash process to cover with credit rules:
  • What to do before sending a quotation?
  • Risk assessment and mitigation
  • Internal Chart of Authority
  • Cash collection process and dispute management process
  • Litigation recovery


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Last comments

csapalo
I have found the credit management NOTES very helpful and I think these have aroused interest in taking a course credit management course. I recommend others to read this website
Darshan Pansare

please confirm if all tools available in english language.

Editor's answer :

Yes, all tools are available in english

Lebogang Mogotlhwane
Very insightful article. Showing that credit management is everyone's responsibility in the organisation; not just the credit manager's.

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