Credit management is a process of granting credit facilities for the customers, establishing payment terms and conditions that allows the customers to pay their due amounts in full and on time, payment recovery activities, and ensuring the customer adherence to the business organization’s credit policy. It is considered as the business organization’s action plan to protect against late payments and defaults from the customers of the business.
It is estimated that one in five business bankruptcies of small-scale businesses occurs due to not receiving the given credit facilities back as the customer’s default on their invoices. Apart from that, receiving late payments from customers can create adverse effects on the business’s creditworthiness. This highlights the need of maintaining a proper credit management strategy for the success of any business.
Being continuous, ability to evaluate the potential losses, being able to proactively identify risks and strategically guard against the risks by maintaining a strong risk management process is considered a component of an effective and successful credit management strategy.
Offering credit to the customers can be identified as a great way to increase sales and it can be helpful in developing strong customer relationships. However, an inadequate credit management process could create an adverse impact in receiving payments from the debtors and it can lead to creating a negative impact on the creditworthiness of the business.
Some customers show a relatively low non-payment risk. However, even though the customers have a long history of making on-time full payments, there is always a risk involved with offering credit facilities.
The key method of managing this risk is to maintain a good credit management strategy. Five main elements can be identified as key factors of maintaining a good credit management strategy.
1. Assessment of credit rating
It is the business managers’ decision to agree on the level of risk the business organization is willing to accept. The risk conditions should be implemented based on the level of risk. Apart from that, it is ideal for the business to check the customers’ credit risk before providing credit facilities. Businesses should implement a method to avoid providing credit facilities for customers with poor credit scores and encourage them for cash transactions.
If the customer has a credit score that can be acceptable by the organization, the management can decide on getting into a contract to provide credit facilities. This contract should include every detail about the facility including the exit period that the business wishes to cease trading.
2. Monitoring
It is vital for the business to continuously monitor the customers as the financial conditions of the customers can change without a warning. When organizations are offering credit facilities to the customers, monitoring customers’ financial status continuously also should be included as it will help the management of the business to decide whether the customer is still meeting the required credit score conditions. If the customer does not fulfill the required conditions, a strong credit management strategy will decide to cease business activities with the customer.
3 Managing the customers
When a business has a powerful customer relationship management system, it helps the leaders of the business to manage the relationship it is planning to have with the customers. Payback reminders and other methods of customer communication can be effective methods of managing customers.
4. Invoicing
For the customers to pay their due amounts properly and on time, the business has to issue the invoices promptly and conduct follow-up reminders on the payments that are not received. The business should provide a considerable number of days between the invoicing date to the payment due date.
It is highly important to keep the organization’s bookkeeping system up-to-date so the business management is aware of the payment details of the customers.
5. Mitigating the associated risks
Since providing credit facilities is always associated with risk, the business should take necessary actions to minimize the risk. Trade credit insurance can help businesses to mitigate the risk of non-payment. This is done by securing the organization’s account receivables. The insurance usually covers up to 90% of the outstanding amount in a non-payment. This is done with the intention of maintaining the cash flow of the business unaffected.