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Credit management and managing credit in a recession


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  • 1. Credit Management and Managing Credit in a Recession By:Nigel D.St.HillThere is a widespread misconception concerning Credit Management that it isconcerned solely with cash collection. Actually this is far from the truth. I would thereforeseek to highlight some critical issues and in the process broaden the reader’sawareness.Credit Management is the management of one of the business’ most valuable assets -its receivables – this starts from the assessment stage right through to collection.Effective Credit Management yields a substantial pay back in reduced borrowing,interest saved and improved liquidity. It is not simply a “debt chasing” exercise as it isoften referred to.Credit Management depends on the creation and implementation of a credit policywhich establishes systems and procedures for opening accounts; defining the creditworth of the customer; establishing the terms on which goods or services will besupplied; and collecting payment when it is due.Let us now look at three (3) areas in the Credit Management process:  Credit assessment;  Monitoring and controlling amounts outstanding on the sales/account receivables ledger;  Ensuring the supplier is paid for the goods and services renderedCredit AssessmentThis is the stage at which the credit granting decision is made. It is a decision-makingprocess and the decision is crucial, for it is at this stage that offers an opportunity tominimize the risk of bad debt.The potential creditor needs to gather and then needs to evaluate the information inorder to make a decision as to whether it is prudent to grant credit. There are many 1
  • 2. sources of credit information with varying levels of value. However, establishing creditworth is like doing a jig-saw puzzle and these sources are merely parts of the puzzle. Itis only when they are put together that a picture emerges.The objective of credit assessment is to establish the identity of the customer and thatcustomer’s ability to pay. Establishing the correct identity i.e. the correct legal status ofthe customer is the essential prerequisite to grating credit. The potential customer maybe a Public Limited Company; Private Limited Company; Sole Trader; Partnership;Government or Local Government Body; Club; Church, or an Individual.Account Monitoring – credit limitAfter the evaluation of the potential customer, some suppliers normally apply a creditlimit. It is not easy to determine absolute credit limits for customers. The answer canonly be an estimate because of the many unknown factors, not least the change in thecustomer’s liquidity since the last set of accounts if the customer is a business.Having credit limits gives suppliers the opportunity to reassess customers on a regularbasis. If there was no limit no brake will be placed upon the account at any stage. Whencredit limits become inadequate they should be updated.Cash CollectionThe granting of credit means taking a risk. There is no guarantee that goods andservices received on credit terms will be paid for or paid on time. All suppliers musttherefore have procedures which encourages the customer to repay as agreed, hence acash policy.A developed cash policy is essential if sales are to be turned into cash at a rate whichenabled current liabilities to be met promptly. Preparing a collection policy must includerecognition of needs for; 2
  • 3.  Flexibility to cope with varying sales levels in varying economic climates e.g. during a recession.  Priorities which will support the central objective of maximizing debtors for the shortest possible time e.g. key customers, special terms, marginal sales, cash only.  Adequate in-house liaison particularly with production, sales, computer and dispatch departments. Essential where credit limit observance is required and marginal business is necessary. Credit Management in a RecessionBasic FunctionCredit Management is the management of one of the business’ most valuable assets –its receivables – this starts with the assessment stage right through to collection.Effective Credit Management yields a substantial pay back in reduced borrowing,interest saved and improved liquidity. It is not simply a “debt chasing” exercise as it is sooften referred to. Credit Management depends on the creation and implementation of acredit policy which establishes systems and procedures for opening and monitoringaccounts; defining the credit worth of the customer; establishing the terms on whichgoods or services will be supplied; and collecting payment when it is due.RecessionIn a recession the problems of credit management become more acute for two basicreasons; first previously good customers may well face new problems and their ability tocope with them will influence their ability to maintain their payments to you; secondly, 3
  • 4. there will be additional pressure upon the credit department to support the salesdepartment by approving orders from customers who would not normally be consideredof prime credit worthiness.In a recession the survival rate of your own company is the first consideration. Theimmediate reaction might well be to decide that the credit policy should be tightened toensure that the company is not exposed to any greater credit risk than before. This isthe reaction of most companies, at least initially. However, this is where the combinationof expertise of sales and credit departments comes to the fore. The real need is tomaintain sales at a profitable level and that may mean that it is necessary to revise boththe sales and the credit policies.Why should this be? First, if the market is in decline, the sales force may be chasingorders from a smaller number of customers or, because of contraction of the industrywhich still has the same number of companies within it, chasing larger orders from thecompanies still able to place orders. Either way, the credit department, has twoproblems; first should the level of credit be increased, perhaps by extending the periodof credit granted, perhaps by increasing the credit limits applied to existing customers;secondly, should the sales force be encouraged to seek orders from companies whowould not previously have been considered to be first-class risks-and if so, how shouldcredit limits and credit periods be decided? 4
  • 5. Of course, much depends upon the nature of the business. A company with a widespread of customers may be better placed to adjust credit terms for a few customerswithout upsetting the main credit policy. More likely, however, if one company starts tooffer easier credit terms their competitors will not be far behind, if they can afford it (or ifthey cannot afford it to lose the business). Hard decisions have to be taken here. It is avery difficult matter to decide to start a credit war. If you grant easier terms and yourcompetitors match them, both of you have lost, unless by doing so you have kept goingsome customers who would otherwise not have survived. However, that is more a casefor individual decision, within the overall credit policy, rather than for a blanket creditpolicy decision such as was considered here.© Nigel D St.Hill 2012 All rights reserved.Nigel St. Hill is a life and money management coach helping people to unlock theirdoors to abundance, so that they could live the life of their dreams. He worked withCable & Wireless (now LIME) as their Credit Manager and was the first person in theCaribbean to be qualified in Credit Management. He has been a contributing columnist,having written numerous articles in the local newspapers and magazines and the “In theZone Magazine,” and “Caribbean Success University” both based in the U.S.A. He isthe author of the book, Money Management Caribbean Style and several ebooksincluding The Easy Cash Flow System and How to Keep Your Doors Open in aRecession. For more information on Money Matters e-mail: and visit my website 5