5 Keys to Effective Credit Management

Unless you’ve been sound asleep for the last several months, you know that the
global economy is in a serious crisis. And it’s not just the brokerage houses and
financial institutions that are in trouble. Businesses around the world are facing
formidable challenges in a struggle to survive.

Most companies are not going to get multi-million dollar government bailouts. It’s
up to each company to make the tough decisions, chart its own course, and take a
hard look at what it needs to do to survive. Getting serious about efficiency and
effectiveness in handling receivable management needs to be a focus.

According to the Association of Executives in Finance, Credit & International

Business (FCIB): “As global markets tumble and bank lending freezes, the role of
trade credit as the main source of cash has become even more prominent.”

The Credit Research Foundation, in a recent publication – Lessons for Business to

Learn from Today’s Credit Crisis – makes corporate priorities clear: “Your
organization’s mission at this point should be to abandon the thrust to increase
revenues and garner market share in favor of increasing cash flows and
profitability.”

Credit and receivables have stepped to center stage. And it’s time to get serious
about improving management of this increasingly valuable asset.

Key #1 –Effective Credit and Collection Policy

Effective credit management is about developing consistency in your credit and
collection processes. This, in turn, will ensure efficiency in your entire revenue cycle.

The secret to consistency is a thoughtfully designed and actively implemented

credit and collection policy. Such a policy has power to breathe new life into your
entire credit-to-cash process. Even if you already have a credit and collection policy,
it’s important to review it on a regular basis to assess its effectiveness and to make
sure you are following it.

The CRF (Credit Research Foundation) web site’s Credit Assistant is one of the best
resources available on the particulars of credit management. Click on “Credit
Assistant” on the CRF home page (www.crfonline.org) and you will find a wealth of
information on just about every aspect of credit management.

For help in developing your credit policy, select “Organization and Administration”
from the left-hand navigation on the Credit Assistant home page. Then click on
Developing a Credit Policy. This article even includes a credit policy worksheet to
help you develop your own policy.
Key #2 – Due Diligence
As lines of credit dry up, your customers are going to start looking to trade credit as
a source of working capital. Current customers may ask you to extend your terms or
stretch out their payments. New customers may request very liberal open account
terms.

But beware – now is not the time for short-cuts in credit decision-making. Treat
every credit sale as if it could become a potential collection issue.

With current customers, don’t assume they’re okay now because they were okay
last year. Review the creditworthiness of all of your important customers. Today’s
business climate is erratic, to say the least. Companies that appeared secure six
months ago may now be on the verge of collapse. Set up regular reviews to monitor
each customer’s creditworthiness to keep a step ahead of bad debt write-offs. In
particular, credit applications, financials and participation in industry credit groups
can help you develop the information necessary to making a reasonable decision
about extending credit to both new and existing customers.

Credit Applications

If you don’t normally use credit applications, start using them now. If properly
constructed and executed, the credit application serves as an information-gathering
tool that can also function as an enforceable document if litigation becomes
necessary.

Financial Information

Consider this. When you go to your banker for a loan, you expect him to require
financial information. When a potential buyer asks you for credit terms, the
extension of credit is no less a loan than that given by your bank. Yes, financials are
often difficult to obtain. But an analysis of financials is critical to determining
whether a customer is worth the risk of an unsecured credit facility.

Again, the “Credit Assistant” section of the Credit Research Foundation provides
valuable information on Financial Statement Analysis. Click on the Customer
Financial Assessment section (Task Index) to find a series of topics on Customer &
Financial Statement Analysis.

Industry Credit Groups

Credit managers routinely use credit bureau reports as a source of data for
determining the creditworthiness of a customer. These reports may include general
and dated information on a company's financial position and credit history from
various unidentified sources. In recent years, commercial credit reporting agencies
have enhanced their offerings with items such as credit scoring, on-line access, and
links to websites containing public record information.
These one-size-fits-all credit information solutions fall short, however, when it
comes to providing the industry-specific information credit managers need to round
out a customer's financial profile and payment history.

Recognizing the limitations of traditional generic trade reports, credit professionals

are discovering that membership in industry credit groups fills the gaps, helping
them develop more complete credit histories on both new and returning customers.
The net result is a faster, more accurate, cost effective solution for managing the
risks associated with extending credit.

Key #3 – Protect Your Sale Wherever and However Possible

There are a number of ways to protect your sale when selling domestically or
internationally.

The place to start is at the beginning. By appropriately structuring your sales

contract (and/or credit application), you can build future protection in case you need
to litigate. A well-written contract can make the litigation process easier and faster,
and the likelihood of success much higher.

The Bernstein Law Firm outlines three things you can do to Improve Your Chances of
Collecting from a Risky [Any] Customer: (1) get written personal guaranties of
payment from your customer’s principals; (2) retain a security interest in various
assets; and (3) include a confession of judgment clause as part of your sales
agreement or credit application.

Certain sales instruments also offer extra security when selling on credit. Including:

• Letters of Credit – see CRF Credit Assistant (Collateralization / Securitization)

• Bills of exchange (D/P and D/A Transactions)

Also consider factoring (CRF Credit Assistant – Collateralization / Securitization) or

trade credit insurance, and, of course, perfecting a security interest in your
customer’s assets

Key #4 – Focus on Cash Flow

Businesses today cannot afford excessive write-offs or large numbers of delinquent
accounts. Few business owners will dispute the fact that cash is king. A lack of
operating cash was the primary “cause of death” for many U.S. “dot-coms” in the
early 2000s. Poor cash flow management continues to result in the collapse of
business enterprises, large and small, worldwide.

One of the most common cash traps is uncollected sales, a.k.a. accounts receivable.

How can you improve your cash flow? By reducing your Days Sales Outstanding
(DSO). And how can you reduce DSO? By training your customers to pay on time –
and that requires constant attention and follow-up. With receivables, it’s really “the
squeaky wheel that gets the grease”. You want to be at the top of your customers’
payment list. How do you get there? Either by providing the most essential product
or service; the one your customer can’t stay in business without. Or, by regular
follow-up that keeps you in front of your customer on a consistent basis.

In Methods for Improving Collections, another CRF Credit Assistant article, the CRF
recommends “Systematic follow-up of [all] accounts”, which “reinforces the serious
nature of the outstanding debt and emphasizes the importance attached to it by the
creditor [you].” Also, “it is important [essential] to keep contacts on a strict
schedule.” The CRF encourages every credit department to set up a matrix of
delinquent customer contacts, which might start shortly after the invoice becomes
delinquent.

We recommend you consider following up even before the invoice becomes due. A
letter or call letting the customer know the product has been shipped, when it
should be received, whom to contact if there are any questions or issues, and when
payment will be expected goes a long way toward a happy client and on-time
payments.

Key #5 – Know When to Call in Outside Assistance

No one can do it alone. Many credit professionals struggle under the weight of
increased scrutiny, expanded responsibilities, and static resources. Bogged down
with daily operations and growing responsibilities, how can you make the changes
necessary to improve overall business performance?

One way is to outsource 1st or 3rd party collections.

First-party Collection Outsourcing

First-party collection outsourcing is nothing to be afraid of. Most credit departments

today cannot afford to hire all the staff they require to touch all of their credit or
delinquent accounts.

The organizational benefits of outsourcing are well documented. A recent survey by

The Hackett Group noted that “World-class companies spend a higher percentage of
time on strategic vs. transactional activities. World-class companies outsource
66.6% more than non-world class firms.”

By providing a consistent, efficient, technologically current process, outsourcing A/R

collections offers opportunities to address the immediate challenges facing credit
managers. At the same time, the systemic improvements that come with
outsourcing create benefits that will help the credit department achieve its broader
goals.

For those not yet ready for a total outsourcing commitment, a partial outsourcing
solution offers a low-risk entry into outsourcing’s benefits. By outsourcing only a
selected portion of its A/R function, the organization can determine if it: (1) is
comfortable with outsourcing in general; (2) has selected a provider with the right
capabilities; and, (3) has the internal capabilities to successfully manage an
outsourcing project.

Among companies that should definitely consider partial outsourcing are those that:
require a few more receivable collection FTEs (full-time equivalents); have
occasional need for increased staffing; or, feel their internal processes are
ineffective and would like to benchmark them against a professional receivable
management firm.

Third-party Collections

Even with the best credit management procedures and great care in approving
credit customers, some accounts are going to go past due. And most companies, at
some point, need the services of a professional collection agency. Professional
commercial collection agencies have the clout and local contacts to convince your
debtor you’re serious about collecting your money. They can also help with legal
action and most have networks of attorneys that can sue in any jurisdiction. If your
buyer hasn’t paid in 90 or more days, you shouldn’t hang onto the account any
longer. Another advantage: most collection agencies work on a no pay/no fee
(contingent) basis. So, in essence, you have nothing to lose by placing an account
with them. If they can’t collect it, you don’t have to pay them.

Focus Your Efforts on Effective Credit Management

Your company didn’t cause the current credit crisis – but it’s going to be up you to
ensure your business survives it.

1. An effective credit and collection policy

2. Due diligence
3. Protecting your sales
4. Focusing on cash flow
5. Seeking outside assistance

These 5 Keys to Effective Credit Management provide a valuable check-list to help

you focus your efforts.