Credit Management is a branch of accountancy, and is a function that falls under the label of “Credit and Collection’ or ‘Accounts Receivable’ as a department in many companies and institutions. They will usually deal with the credit vetting of customers, the resolution of any invoice queries or disputes, allocations of payments or cash application, internal fund movements, reconciliations and also maintaining positive working relationships with customer during the debt collection or credit review and approval process.
Credit Management has evolved now from being a pure accounting function into a front-end customer facing function. It involves screening of customers and only those who are credit worthy are allowed to do business. A sound review of the financial position of the customer, and understanding of their business model is the first step in ensuring that the company does not end up selling to a customer who ends up seriously delinquent or in default. Hence, before the sales function commences its business with the particular customer, the credit management role begins. Later as the customer starts dealing with the company, the accounts receivable function is used to ensure recovery as per agreed terms of credit is followed (H.O. Moti, J.S. Masinde 2012).
The importance of credit management
Some companies do their utmost to bring in new business, but may falter at the last hurdle of ensuring that deals turn in to ‘paid deals’. Over half of all bankruptcies are attributed to poor credit management – signifying its importance. Credit management involves much more than reminding customers to pay. Rather, it involves gaining a thorough examination and process of detecting possible reasons of non-payment, perhaps even whether a solution or product was not delivered and even as far as the invoicing containing discrepancies (O. Chigozie, B.Ch. Okoli 2013).
Effective credit management is a comprehensive process consisting of:
- Determining the customer's credit rating in advance
- Frequently scanning and monitoring customers for credit risks
- Maintaining customer relations
- Detecting late payments in advance
- Detecting complaints in due time
- Improving the DSO
- Preventing any bad debt from arising
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. 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 (G. Donnelly, M. Ksedzova 2013).
Person which intervenes in the full sales process of the company, from commercial prospecting to final payment of invoices. He works in collaboration with the sales department and the legal department. He is responsible for the good management of customer outstanding, that is to say the turnover recognized and not yet paid.
It is refers to the probability of loss due to a borrower's failure to make payments on any type of debt. Credit risk management is the practice of mitigating losses by understanding the adequacy of a bank's capital and loan loss reserves at any given time – a process that has long been a challenge for financial institutions. To comply with the more stringent regulatory requirements and absorb the higher capital costs for credit risk, many banks are overhauling their approaches to credit risk. But banks who view this as strictly a compliance exercise are being short-sighted. Better credit risk management also presents an opportunity to greatly improve overall performance and secure a competitive advantage.
Examples of Credit management
- Credit management involves the management of a company's credit policy and the implementation of credit decisions. This includes the review of customer creditworthiness, setting credit limits and terms, and monitoring customer payment history.
- Credit management also involves the collection of outstanding debts, including debt collection agencies and legal action.
- Credit management also involves financial reporting, budgeting, and forecasting of future credit requirements. This involves developing strategies to manage credit risk and increase credit availability.
- Credit management includes managing credit lines, which includes reviewing and approving customer applications, setting credit limits, and monitoring payment performance.
- Credit management also involves the negotiation of payment terms and the preparation of credit agreements. This involves analyzing customer financial statements, credit reports, and other data to determine creditworthiness.
- Credit management also involves monitoring and reporting on credit activities, such as changes in customer credit ratings, customer payment patterns, and changes in customer credit limits.
- Credit management also involves managing disputes, including the review of customer complaints and the resolution of disputes.
Advantages of Credit management
Credit management is an important part of financial operations for businesses and other organizations, as it helps to ensure that the organization’s cash flow is not overstretched. Below are the advantages of credit management:
- It helps to ensure that the organization receives payments in a timely manner, and reduces the risk of default on payment. This helps to ensure that the organization’s cash flow remains positive.
- It allows an organization to reduce the amount of bad debt, as it encourages customers to pay their invoices in a timely manner.
- It helps to ensure that customers are up-to-date on their payments and reduces the risk of late payments.
- Credit management helps to reduce the amount of time needed to handle accounts receivable, as the process is streamlined.
- Credit management also allows an organization to identify customers who are likely to default on their payments. This allows the organization to take the necessary steps to minimize bad debt.
- Credit management also reduces the cost of doing business, as it reduces the need for additional staff or resources to handle accounts receivable.
- Finally, credit management can also help to improve customer relationships, as customers will be more likely to pay their invoices in a timely manner.
Limitations of Credit management
Credit Management is a vital part of the finances of any business, however, there are certain limitations that come along with it. These include:
- Inability to predict customer behavior: Credit Managers cannot predict the behaviour of customers and potential customers accurately, which can lead to unanticipated bad debt.
- Lack of control over external factors: Credit Managers are limited in the ways in which they can control the external factors that can influence the creditworthiness of customers, such as the state of the economy, market trends, and changes in the law.
- Determination of credit limit: Credit Managers must determine the credit limit for customers, but this can be difficult to do accurately and may lead to potential losses if the limits are set too high and customers default on their payments.
- Fraudulent activity: Credit Managers must be alert to the possibility of fraudulent activity, such as customers using false identities, but it can be difficult to detect this and prevent losses.
- Time-consuming: The credit review and approval process can be time-consuming, which can lead to delays in getting customers approved and can reduce the efficiency of the company.
- Credit Risk Management: This involves assessing the amount of risk associated with a loan or a line of credit and taking steps to mitigate any potential losses. This can include developing credit policies, assessing customer creditworthiness, and setting credit limits.
- Credit Analysis: This involves analyzing a customer's financial statements and other documents to assess the customer's creditworthiness. This can include reviewing financial statements, conducting financial ratios, and evaluating cash flows.
- Credit Monitoring: This involves monitoring loans and lines of credit to ensure that payments are being made on time and that credit limits are not being exceeded. This can include reviewing customer payments, preparing monthly reports, and setting up credit limits.
- Credit Collection: This involves collecting outstanding debts from customers. This can include sending reminder letters, following up on delinquent accounts, and initiating legal action.
In conclusion, credit management consists of a number of different approaches, including credit risk management, credit analysis, credit monitoring and credit collection. By utilizing these approaches, companies can minimize their risk and maximize their profits.
- Chigozie O., Okoli B.Ch.(2013). Credit Management and Bad Debt In Nigeria Commercial Banks–Implication For development, "IOSR Journal Of Humanities And Social Science" Volume 12, Issue 3.
- Donnelly G., Ksedzova M. (2013). Sadness, identity, and plastic in over-shopping: The interplay of materialism, poor credit management, and emotional buying motives in predicting compulsive buying, "Journal of Economic Psychology" Volume 39.
- Moti H.O., Masinde J.S. (2012). Effectiveness of Credit Management System on Loan Performance, "International Journal of Business, Humanities and Technology", Vol. 2 No. 6.
Author: Maria Drzazga