Credit is one of the most important success factors for a company that sells products or services to permanent customers and customers; it helps attract new clients, keeps current customers and increases sales volume. However, it also includes significant risks such as delays or non-payment of debts, depreciation of guarantees or changes in economic or regulatory conditions. Therefore, companies must effectively manage credit to maintain their financial health and sustainability.
Credit management is the process of identifying and assessing credit risks and establishing policies and procedures to reduce and control them. This process aims to increase revenues, reduce costs, and improve the liquidity and profitability of companies that sell credit products and services. Some examples of these companies are banks, financial companies, insurance companies, e-commerce companies, and telecommunications companies.
In this article, we will discuss the steps of credit management, highlight the challenges that companies face in this area, and identify the best practices that can be used to improve this process.
The importance of credit management in companies
The management of credit in companies is of great importance for a number of reasons, including:
Increased revenue: Credit helps attract and retain customers and increase the volume of sales by any company, and companies that provide concessional and client-friendly credit terms have a competitive advantage over firms that impose stringent or lenient conditions. Credit also contributes to improving company relationships with clients and increasing their satisfaction and loyalty.
Reducing costs: Credit management helps reduce costs associated with accounts receivable, such as collection costs, discounts, interest, and losses. It aims to identify and reduce credit risks and mitigate their impact on the company using tools and techniques such as financial and non-financial analysis, credit classification, and guarantees to reduce the level of risk.
Improving liquidity: The management of credit helps to improve the liquidity of the company, i.e., its ability to pay its financial obligations on time, with a view to increasing the pace of capital turnover, i.e., the average time it takes for the company to convert its debtor accounts into cash. To achieve this, the Credit Department uses effective collection policies and procedures to ensure that amounts due from clients are recovered in the shortest possible time.
Increase profitability: The credit administration helps increase the profitability of the company, i.e., the ratio of net profits to net sales. It aims to increase the profit margin, i.e., the ratio of net profits to gross sales, and the capital return, i.e., the ratio of net profits to capital.
Best practices in credit management
Establish effective credit policies that meet the company’s objectives and are proportionate to the type and size of customers and industry: Credit policies define the criteria for granting credit, payment conditions, and the mechanisms for approval, control, and collection. Credit policies must be flexible and adjustable to changes in market and economic conditions.
Use of financial and non-financial analysis to assist in the decision to grant credit: Financial analysis includes the examination of customer financial lists and the calculation of ratios such as coverage ratio, repayment ratio, storage ratio, conversion ratio, debt-to-capital ratio, profitability ratio, and capital return ratio, as well as consideration of factors such as customer record and reputation, nature of the industry, volume of demand, level of competition, and legal and fiscal implications.
Determination of the function and role of debtor accounts in companies: The debit accounts are the amounts owed by the company to its customers for the sale of credit products or services. The role of the management of accounts receivable is to record, assess, and bill clients; monitor the turnover of capital; reconcile documents; monitor collection; solve problems; and prepare reports.
Adopt an effective collection policy: collection is the process of recovering amounts due from clients, and a collection policy sets out steps and procedures to ensure prompt and efficient collection. Some of the best collection practices are:
- Set clear and logical payment deadlines.
- Send periodic reminders and claims.
- Use multiple means of communication, such as telephone, e-mail, and text messages.
- Provide incentives or discounts for early payment or cash.
- Delegation of qualified and trained staff for collection.
- Negotiating with clients who are in trouble for soft payment schemes.
- Use collection agencies or the judiciary in the event of failure to collect the required amounts.
Assessment of accounts receivable: The assessment of accounts receivable is aimed at measuring the performance and efficiency of credit management and collection and identifying strengths, weaknesses, opportunities, and threats. Some of the best practices for assessing accounts receivable are:
- Use an integrated and automated accounting system.
- Update customer data regularly.
- Document all transactions and communications.
- Conduct periodic audits of accounts receivable.
- Analysis of financial and statistical reports.
- Apply quality and ethical standards.
What are the challenges of credit management?
Credit management faces many challenges in the face of rapid and continuing changes in the market and business environment. Some of these challenges are:
Regulatory complexities: Companies providing credit services are subject to numerous laws, regulations, and standards aimed at protecting the rights and interests of consumers, regulators, and bankers. These regulations require companies to follow transparent, fair, and secure credit practices, to conduct solid feasibility studies, to prepare periodic reports, and to comply with established limits and ratios. The management of credit requires keeping pace with updates and changes in the organization, controlling its policies and procedures accordingly, and ensuring that all staff comply with applicable rules.
Economic changes: The state of the local and global economies has a significant impact on credit risks. In periods of recession, crisis, inflation, or volatility, debtors are finding it increasingly difficult to repay their debts, and their ability to obtain income, security, or insurance is reduced. Also, competition among credit service providers is increasing, interest rates are declining, and claims for early settlement or reduction are increasing. Credit management therefore requires constant control of market movement, demand and supply, analyses of different scenarios, restructuring, rescheduling, or renegotiation of credit terms as needed.
Technological innovation: Technological developments open up new prospects for credit management, enabling enterprises to improve the efficiency, speed, and accuracy of credit processes, provide dedicated, flexible, and diversified credit services, and enhance communication and interaction with clients. However, companies face challenges in adapting to these technological changes, requiring significant investments in infrastructure, systems, and programs, staff training and qualification, and data and privacy protection. Also, with technological developments, the risks associated with fraud, piracy, or malfunctions are increasing. The credit management process therefore requires keeping pace with technological progress, exploiting its opportunities, and overcoming its obstacles.
Credit management steps
Credit management steps can be summarized as follows:
Client analysis: This step aims to collect and evaluate financial and non-financial information about a potential customer, such as identity, record, reputation, ability, and intent to pay. The credit analyst uses tools such as lists, financial ratios, credit ratings, guarantees, and insurance to determine the level of risk and creditworthiness of the client.
Decision on credit: This step is aimed at deciding whether to grant, reject, or modify the request for credit by the customer. The decision is based on the results of the credit analysis and the company’s policies, procedures, and standards. Decision-makers shall issue credit approval, refuse to grant credit, or provide conditional credit approval, specifying the terms and conditions of credit, such as amount, interest, schedule, and guarantees.
Establishment of a credit relationship with the client: This credit management step is aimed at implementing the credit decision and concluding a credit contract between the company and the client. This step requires the verification of all terms and conditions specified in the credit approval, such as the provision of documents and guarantees. Also, all credit relationship transactions and communications are required to be recorded in an automated accounting system.
Monitoring the credit relationship: This step aims to monitor the progress of a credit relationship periodically to ensure that both parties comply with the terms and conditions of the contract and to detect any indications of deterioration or change in the quality, efficiency, or integrity of the credit relationship. A credit controller uses tools such as financial and statistical reports and accounting records to make updates, corrections, and precautionary or corrective actions as needed.
Termination of the credit relationship: This step is aimed at ending a credit relationship after full recovery of the receivable, interest, and charges by the customer, or after settlement, reduction, or write-off of the defaulted amount by the company. This step requires the issuance of a blank certificate or certificate that eliminates the client’s indebtedness, the cancellation or return of guarantees, and the closure of accounts and records relating to the credit relationship.
It has become clear, therefore, how important it is for companies and enterprises to manage credit in the financial and commercial sphere; the steps of credit management are not a set of administrative procedures but an integrated strategy that contributes to the protection of financial interests and the promotion of the economic success of any enterprise.
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