Introduction
Credit management is a critical aspect of any business that sells goods or services on credit. It encompasses the processes and procedures used to secure timely payment for products and/or services while reducing the risk of late payments or defaults. In this article, we will explore credit management strategies that businesses can implement to manage credit risk, increase cash flow, and improve profitability. Understanding these strategies can help you make informed decisions and mitigate credit-related risks in your organization.
Why are credit management strategies important?
Effective credit management strategies are crucial for businesses for several reasons:
- They help maintain a healthy cash flow by ensuring timely payments from customers, reducing the risk of payment delays or defaults.
- They minimize credit risk by implementing appropriate credit policies and procedures to assess customer creditworthiness and avoid extending credit to high-risk customers. This minimizes the risk of bad debt and write-offs that can negatively impact financial health.
- They improve profitability by reducing borrowing costs and optimizing working capital, leading to improved financial performance and increased profitability.
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What is a credit policy?
A credit policy is a set of guidelines and standards used to determine which customers are granted credit and extended payment terms. Establishing a comprehensive credit policy is essential for any business that sells goods or services on credit.
Types of credit policies
In credit management, there are two primary types of credit policies:
1. Lenient credit policies apply very few restrictions on credit terms. Businesses with this type of credit policy may extend credit to customers whose creditworthiness is unknown or in doubt. This strategy can be effective in the short term, as it can increase sales and attract new customers. However, lenient credit policies also carry a higher risk of default, which can lead to significant losses for the company and negatively impact liquidity.
2. Restrictive credit policies apply strict restrictions on credit terms. Businesses with this type of credit policy only extend credit to customers who are deemed creditworthy. This approach can reduce the risk of losses, but it can also limit sales growth and turn away potential customers who may have difficulty meeting the strict credit requirements.
Businesses should aim to strike a balance between lenient and restrictive credit policies. A balanced credit policy will help to minimize the risk of losses while also allowing the company to attract and retain customers.
For example, a company may use a lenient credit policy for small purchases or for customers with a record of paying their bills on time. This approach can help to increase sales and build customer loyalty.
On the other hand, for larger purchases or for customers with a history of delinquency, the company may use a more restrictive credit policy, requiring additional documentation or collateral. This approach can help to reduce the risk of losses while still allowing the company to do business with these customers.
Establishing good credit policies
A well-structured credit policy typically includes criteria for evaluating a customer's creditworthiness, defining credit limits, setting payment terms, and establishing procedures for handling late or delinquent payments. By implementing a solid credit policy, businesses can maintain a healthy financial position and reduce the risk of unpaid invoices.
Here are some key components of good credit policies:
- Mandate a credit application process: It’s important to have each customer complete a credit application so that you can conduct a thorough credit analysis. Make sure to gather the following essential information on the application:
- Legal name of the business
- The business’s operating name
- Type of business
- Physical address of the business
- Contact information
- Financial information
- References from financial institutions and creditors
- Conduct credit checks: Check a customer's credit history to assess their creditworthiness before extending credit. This helps to avoid extending credit to high-risk customers and reduce the risk of bad debt.
- Set appropriate credit limits and periods: Define the maximum amount of credit a customer can receive and the length of time they have to pay. This helps businesses manage credit risk and ensure timely payments from customers.
- Set clear payment terms and conditions: Specify payment due dates, methods, and any penalties or fees for late payment. Clear payment terms can help ensure timely payments and reduce disputes.
Effective credit management procedures
Businesses need to implement effective credit management procedures in order to manage their credit risk, maintain healthy cash flow, and improve profitability. Here are some key components of effective credit management procedures:
- Create a strategic plan for receivables management: Define credit policies and procedures, establish goals and objectives, and identify tools and resources required. A strategic plan helps optimize credit management practices to align with the organization's financial objectives.
- Regularly monitoring accounts receivable performance: Track key metrics like DSO and accounts receivable aging to identify potential issues early and take proactive steps to address them.
- Document payment histories and the financial health of customers: Maintain accurate records of customer payments, credit limits, and credit periods, and track changes in customers' financial health. This helps assess creditworthiness and make informed decisions about extending credit.
- Automate collections: Streamline credit management procedures and improve efficiency with software that generates invoices, tracks payments, and sends reminders to customers who are overdue.
- Assign a dedicated credit manager: Oversee credit management procedures, set policies and procedures, monitor accounts receivable performance, and manage debt collection.
- Maximize cash flow through debt collection practices: Develop an action plan for late payments and bad debts and use appropriate strategies like early payment discounts or professional debt collection agencies.
Implementing effective credit management procedures can benefit businesses of all sizes and industries. Regularly reviewing and updating these procedures can help businesses adapt to changing market conditions and maintain financial stability.
Leverage AR automation to mitigate credit risk
Quadient's AR Advanced Credit module enables business-to-business (B2B) AR teams to effectively mitigate credit risk and expedite reliable sales by equipping them with comprehensive, real-time credit data.
Accurately forecast payor behavior, streamline new customer onboarding, and execute better business planning with instant access to customer credit information at any time.
Let’s explore four key benefits organizations can expect from the technology.
1. Customizable scorecards for every customer: Eliminate the need to run external credit checks. The platform automatically imports data from agencies such as Dun & Bradstreet and Creditsafe and combines it with Quadient AR’s detailed payor history. This information is presented on customizable scorecards, enabling finance professionals to immediately gauge customer reliability.
2. Instant access to information: With comprehensive insights, businesses can tailor their approach to each customer based on their propensity to pay. Approvals, denials, and control of credit limits can be handled with flexibility. Companies are free to adjust credit limits in accordance with risk management plans and future objectives because they are not restricted to a one-size-fits-all strategy. This ability to adapt fosters improved customer relationships while protecting revenue.
3. Improved company-wide communication: All of this essential data is organized and displayed on Quadient AR’s intuitive, cloud-based dashboards. Finance teams can make the data available to other functions at any time, from anywhere. For sales, this means they can accelerate onboarding while feeling confident in the customers they elect to work with. Since finance teams have total visibility into their portfolio and the payments they expect to receive, the unified dashboards also improve cash flow forecasting.
4. Faster customer onboarding: Improved functionality speeds customer onboarding. When creating a client record, all pertinent documents, such as tax exemption certificates, can be uploaded to the platform. This results in a quick sales process where all the information is available from the start.
Conclusion
Effective credit management strategies are crucial for businesses as they help maintain a healthy cash flow, minimize credit risk, and improve profitability. A well-structured credit policy includes criteria for evaluating a customer's creditworthiness, defining credit limits, setting payment terms, and establishing procedures for handling late or delinquent payments. Good credit management procedures include creating a strategic plan for receivables management, regularly monitoring accounts receivable performance, automating collections, assigning a dedicated credit manager, and maximizing cash flow through debt collection practices. Implementing effective credit management procedures can benefit businesses of all sizes and industries. Finally, leveraging AR automation with tools like Quadient's AR Advanced Credit module can help mitigate credit risk and streamline credit management procedures.
