The effectiveness of credit management depends largely upon the person(s) responsible for the function. Many credit managers were poorly qualified, with little formal training, quite lowly paid and of relatively junior status. Maybe it is time for companies to revalue their credit control department, it is just as important as the sales, marking and production.
Credit Management
B Edwards (1993:8) cited a sensible directive to the credit management function is:
“Find ways to take orders without taking unacceptable risks.”
In other words, progressive companies have a positive approach to accommodating their customer’s need for ‘time to pay’, but do not neglect the costs of doing so in pricing and profit planning.
In many companies there is no such person as credit manager or credit controller. It usually falls to a member of the accounting staff to look after the sales ledger and to organise cash collection. Credit control is not regarded as his principle responsibility and all too often credit work is fitted in when time permits, or when a cash crisis occurs.
Many of the companies who do employ a full time credit manager regard him as a debt collector of relatively low status in the hierarchy. It is very easy for the credit manager to be regarded as a negative figure whose purpose is to restrict sales, impose limits, demand money and stop deliveries. The status of the credit manager can only be improved by a more enlightened attitude by top management, recognising the potential contribution a professional credit manager can give.
The main task of credit management is to overlook the credit standing of both new and existing customers, establishment of terms, having regard to the risk involved and the potential profit. Credit management is not just about debt collecting, collection of optimum cash flow whilst ensuring continuity of business.
Methods of Credit Assessment
When an individual applies for a loan or credit card, the bank or building society will carry out a credit check against the applicant, the credit score will give the lender a general picture of the applicant whether or not s/he can keep up the repayment. It is a risk to issue credit to debtors, there is no guarantee that your customer is going to pay on time, or at all. So there is no reason why a company should not carry a credit check against its customers.
Accurate credit check will increase corporate cash flow and profitability by reducing the level of bad debts and the number of account which are overdue. However companies must attempt to strike a balance between a too conservative policy which might lead to the rejection of orders which are considered risky, and accept orders where delays or default in payment are very likely to occur.
New customers represent the major decision area, but it is also important for companies to be vigilant regarding the continuing credit check of existing customers. Suppliers of goods face two type of credit risk:
- The risk that the customer will not pay at all
- The risk that the customer seriously delay payment
It is very unlikely that a large company such as government department or a nationalised industry will result in bad debt, but it is well known that they take a substantial proportion of their time to settle their invoices. This effect of slow payment could cause a serious cash flow problem with small – medium size companies, or drive them into liquidation.
Controlling Credit Risk
A wide range of possible information sources are available to companies when carrying out a credit check to prospective customers. A Shavick (1998: 15 – 17) cited the most widely used are trade references, bank references, credit agencies. Trade references provide a direct means of checking a prospective customer’s current payment behaviour, and it is normal for a supplier to ask for two trade references before credit is granted. A Shavick (1998: 18 – 19) suggested a few important questions need to be answered from the referee:
- Length of time the company has been trading with the referee – It must be base on long term relationship, if the referee has only been trading with your prospective customer for two months, this information is worthless.
- The credit terms offered – Payment terms are varied so you can decide the payment with your prospective customer.
- The credit limit offered – There might be a chance that the reason your prospective customer approached you, is because he cannot persuade his other suppliers to increase his credit limit.
- Does the company pay within the term – For obvious reason, if your prospective customer cannot pay his supplier on time, it is likely that he will delay your payment as well.
- When was the last time the company purchased from the referee – The information will be worthless if the last transaction was a long time ago.
It is important to check all references which your potential customer has provided, although the customer may have excellent references, there is still a chance that s/he will never pay.
Credit Rating Agencies
Credit rating agencies obtain their information from a variety of sources such as public information, details of County Court Judgments and bankruptcy information. Trade and Industry bodies such as the Council of Mortgage Lenders, the Credit Industry Fraud Avoidance Scheme and the Gone Away Information Network also provide information for Credit Agencies. These bodies also collect and store information about customers, including details of existing loan agreements and historical information about repayment patterns.
County Court Judgments provides an indication of an applicant's previous financial history. Information supplied by loan and finance companies, provides both positive information about your existing loan commitments and also a brief and fleeting insight into your payment history.
Setting and Policing Credit Limits
Limit setting for a new customer is important, the amount should be sensible, it will effect the company’s reputation if the credit limit is vary from time to time.
To limit the level of bad debt, there should be a set of rules from the customer placing their order, to issuing the County Court Judgment.
- A written confirmation of order is essential, even a hand written order with the customer signature can prevent the customer from denying the order.
- Order acknowledgement should be sent to customer before the order is dispatched, therefore the customer is well inform of what is in the order.
- Proof of delivery is vital when it comes to debt chasing. Most common excuse is the customer never received the goods, make sure the proof of delivery is signed and name printed, then attached to the invoice which you will send to your customer and keep a copy of it.
- Statements should be issued every month, it acts as a reminder and your customer can reconcile their account to reduce the time of overdue payment.
- Reminder should be sent when the account is overdue by a week, some companies will telephone their customer rather than sending reminder.
- Stop list should be issued when the account is very overdue, the customer and employees should be informed to avoid conflicts. Usually a letter will be sent to the customer to let them be aware of their account’s status.
The County Court Judgment should be sent when there is no other way of recovering the debt, it cannot be used as a threatening tool and bear in mind, is the debt worth issuing County Court Judgment.
Credit management policy should be clearly defined and written down, all employees and customers should be aware of it and should be informed if there is any change to avoid conflicts.
The Customer Relationship
It is important to maintain a good relationship with your customer since they have the control of when they will settle your invoices. Payment terms should be sent with the credit account application, there are two types of payment terms:
- 30 days account – this means your customer is expected to settle the invoice in 30 days, i.e. invoice dated 01/01/2003 becomes due for payment on 01/02/2003.
- Net monthly account – this mean your customer is expected to settle the invoice at the end of the following month, i.e. invoice dated 01/01/2003 becomes due for payment on 28/02/2003.
If the payment term is not clarified the customer is unlikely to settle his invoice with the net monthly term.
According to Gummesson (1987) long - term relationships with customers are very important, especially where relationships can be more expensive to establish. It can lead to continuing exchanges, and thereby be profitable for both parties. e.g. customers are being served by the same salesperson, which knows them and their needs, therefore they don't have to waste time explaining themselves to a new person every time.
When it comes to debt collection, it is necessary for the credit control person to have a basic knowledge of the product or service, an up-to-date aged debtor lists, a copy of the invoice and the proof of delivery, otherwise it will look unprofessional if the customer start to query the invoice.
Analysing Financial Risk
The effect of overdue accounts is a direct erosion of profit. Now a day businesses will try to attract customers from their competitor by establishing long credit terms. However, since the cost of financing a high level of debtors may outweigh the additional profit.
Liquidity can be defined as the ease and speedy with which current assets can be turned into cash sufficient to meet current liabilities. Stock has to be turned into sales before they can generate cash and it is generally unprofitable to hold large cash balance. Debtors therefore hold the key to liquidity.
A company depends on cash flowing through the system at a certain pace. If debtors are not being turned into cash fast enough, there can be only two reasons:
- Credit terms are too long to support the business
- There is an overdue situation
The credit management should have regular meetings with sales and account management, R Brass (1988) suggested the following items should be included in the meeting:
- Last month’s collection results and debtor figures
- Discussion on problem accounts
- Review of outstanding queries
- Proposed blacklist
- Cash discount
- Should we introduce retention of title clause?
- Should we charge interest on overdue accounts?
- Should we pass our debts to a factor company?
Problems arise with the last three questions, there are advantages and disadvantages with such decisions:
Retention of Title Clause
‘Title of goods remains with the seller until they have been paid for in full.’ A Shavick (1998)
Realistically retention of title clause cannot guarantee you get your goods back, even if you can, you will need to be able to identify each individual item and match up with the unpaid invoice. When this clause is applied and the customer’s business fails, you cannot reclaim the VAT even if you were unable to recover your property.
Interest on Overdue Accounts
This might seem to be another option to speed up the customer’s payment, but the customer might find it off putting. Most of the customer might pay late and ignore it anyway, and some might think paying interest gives them permission to pay later.
Debts Factoring
Invoice payments are made quicker, as a third party - the factor or invoice discounter - will pay you most of the invoice immediately. This helps to speed up your cash flow, particularly important at times when your business is growing quickly.
A factor company, usually controlled by a bank, takes copies of your invoices and pays you directly, between 80% and 85% of the value. The other 15%, less fees and interest charges, is paid to you when the factor receives full payment from your client.
Debts factoring is a well known method of rising fund in a short period of time, the disadvantage of this decision is your customer might think your company is in liquation.
Issues of Credit Control within an Organisation
The company I have chosen to analysis is Grampian Country Food Group Limited, I used to work in the accounts department as a purchase ledger clerk. Since I was working closely with the credit control lady, I noticed a lot of problems of how she runs the department.
Grampian Country Food Group is a UK leading independent food business, it has over 20 sites all over UK mainland and Ireland, as well as Germany and Thailand. The site I used to work for is in Wiveliscombe, Somerset.
The head office of GCFG is based in Aberdeen, they have total control of all departments within the organisation, from issuing accounts to be put on stop to sending payment. Its customers are from private family run butchers to UK top leading supermarkets, such as Tesco and Morrsion. The credit terms vary depending on the size of the company, usually 7 days account with family run butchers and net monthly account with the supermarkets.
Within the site at Wiveliscombe, the sale ledger/credit control send statements to its customers on a weekly basis, incoming payment is matched up at the end of the day. Customer’s account are stopped once the invoice is overdue by 7 days, the customer is not aware of the status of its account and sales department are not informed of customer’s account being stopped. Although the decision is made on site, any action to be taken against the accounts need to go through the head office. The other problem is there is a shortage of staff when people are on holiday or off sick.
There are many problems within the credit control department. Firstly statements should be sent monthly, the weekly statements will put customer off and they might not check its account against the statement. Reminders should be sent when the invoice is overdue and the customer should be informed when its account is stopped. They should also allow another 10 days for customer to pay after the letter is sent.
The relationship between the credit controller and the salesmen is not relatively good. Due to the lack of communications, the sales department never informs the credit controller of any dispute of deliveries or returns, and the credit controller never informs the sales department of any customer’s account being stopped.
There are no meetings between the accounts and sales department, so the information they hold is not kept up-to-date. It is often the case that the sales department gives longer credit terms than what was set by the head office, so the problem arise when the credit controller start chasing payment from the customer.
Paper work within the accounts department is not in good order, proof of delivery is filed separate from the copy invoices, sometime it might be lost or without signature. Customers such as Tesco and Morrison require a signed proof of delivery, it is difficult to obtain and there is a high chance of this debt turning into a bad debt.
Since there is no coverage of staff when an employee has time off, there is a problem in re-instating customer’s accounts once it had been stopped, usually it has to wait until the authorised person returns, and sometimes it takes a few weeks. This will delay the time of order processing and the customer might go else where.
The credit control department needs to be re-organised, full training needs to be given, the improvement of communication is essential to avoid conflicts and keep the high level of reputation of the company.
The computer system should have a default format for statements and reminders. The incoming payment should be dealt with first thing in the morning so the aged debtor lists are up-to-date when it comes to telephone debt collecting. The authority should be decentralised to certain extent, since decision is made within the site, it will reduce the delay of any action to be taken against the customer’s account.
The credit management policy should be written down and given to all departments, regular meetings are important for passing information between departments.
Conclusion
The development of credit management has been stimulated by the need to find more effective ways of granting and controlling credit, as the nature of credit trading has become more complex. Credit terms now often stand alongside price and delivery as key factors in winning orders.
The ever-increasing level of business failures, few with decreasing profit margins, has meant that no company can afford to neglect credit control. Successful credit management requires the operation of tight financial controls with a positive approach to the achievement of profitable sales.
Bibliography
Brass R, (1988), Credit Management, 2nd edition, London, Hutchinson Education
Edwards B, (1993), Improving Cash Flow and Profit, Hertfordshire, Director Books
Edwards H, (1985), Credit Management Handbook, 2nd Edition, Hants, Gower Publishing Company Ltd
Gummesson E, (1999), Total Relationship Marketing: Rethinking Marketing Management (CIM Professional Development S.), London, Butterworth-Heinemann
Hutson T & Butterworth J, (1984), Management of Trade Credit, 3rd Edition, Hants, Gower Publishing Company Ltd
Shavick A, (1998), The Cheque’s in the Post – Credit Control for the Small Business, London, Kogan Page Ltd
29/12/2003
Reference
Brass R, (1988), Credit Management, 2nd edition, London, Hutchinson Education
Gummesson E, (1999), Total Relationship Marketing: Rethinking Marketing Management (CIM Professional Development S.), London, Butterworth-Heinemann
Shavick A, (1998), The Cheque’s in the Post – Credit Control for the Small Business, London, Kogan Page Ltd
Accounting Information Systems -
