Mastering Credit Management: A Comprehensive Guide to Financial Success

Introduction

Credit management is a crucial pillar of any organization’s financial strategy, and its importance cannot be overstated. Credit departments may relate to this even better as they juggle numerous credit applications daily, deciding whether to extend credit. In such cases, even a single poor credit decision may balloon into thousands of challenges, including higher DSOs and increased past dues, which can stop the business from achieving its goal.

Effective credit management can help your business navigate these challenges by identifying and managing them early on. The process involves thoroughly assessing and understanding customer creditworthiness before extending credit and setting appropriate limits to ensure financial stability and resilience.

Reading this guide will help credit managers understand how to effectively manage their credit process and ensure that their company’s financial operation remains fluid and resilient. First, let’s start with the basics!

What Is Credit Management?

Credit management is the process of extending credit on certain terms and conditions after carefully assessing the creditworthiness of the customer. Essentially, it involves analyzing the customer’s ability to repay if they purchase goods on credit to ensure minimal risk exposure for the business.

The organization’s credit team typically assesses the buyer’s creditworthiness by reviewing various factors, such as their credit history, financial statements, and payment behavior. They then decide whether to grant credit and, if so, what credit limit to set. Effective trade credit management can help businesses reduce non-payment risk and improve their cash flow.

Key Steps in the Credit Management Process

The steps involved in the B2B credit management process aim to assess credit risk, set credit limits, and monitor payment behavior. Based on the 5Cs of credit, here are the key steps involved in the credit management process:

1. Review the customer’s credit application

For new customers, credit teams review the credit application to gather detailed business information, credit references, billing and shipping information, and more. Reviewing the customer’s credit application involves assessing their financial stability, credit history, and other relevant information to determine their creditworthiness and suitability for extending credit terms. Existing customers may not require this step.

2. Review the customer’s financial health

Credit teams obtain reports from credit agencies to analyze customer credit ratings and payment scores. They review public financial statements, including cash flow, profit and loss, and balance sheets, to assess financial health. existing customers, they evaluate payment behavior alongside third-party credit ratings and financial data. This comprehensive analysis informs decisions on credit limits and terms, ensuring prudent credit management practices.

3. Ask for credit references

Credit teams request credit references, such as bank and trade references, to verify the buyer’s financial position and creditworthiness. By contacting these references, the credit team can verify the customer’s payment history, reliability in meeting financial obligations, and overall financial stability.

4. Calculate the credit score and credit limit

Credit teams use comprehensive risk models to quantify the customer’s creditworthiness. These risk models are customized to the industry and the credit policy followed by the organization. Various parameters are used in these risk models, and they have different weightages across organizations. These parameters generally fall into the following buckets:

• Financial Health – Income Statement, Balance Sheet, and Cash Flow Key financial ratios (some of them being industry-specific) are used in the model as financial health indicators.
• Payment Behaviour – For existing customers, their payment history acts as a proxy for predicting future payment behavior. KPIs such as average days late (ADL) is used to quantify payment behavior.
• Operational Indicators – Age of business, length of customer relationship, number of employees, number of customers, etc.
• Environmental Factors – Sometimes, it is essential to consider environmental factors such as the country of operation of the customer (factor in political and regulatory risk), the region of operation (if it is prone to natural calamities).
• 3rd Party Credit Agency Rating –The D&B Paydex and Experian FICO scores have relevant weightage in credit scoring models.

Upon calculating the credit score, a credit limit corresponding to that score is assigned to the customer.

5. Get credit approvals

Once the credit limit is assigned, it has to be approved by various stakeholders. For instance, a credit analyst might have the authority to approve credit up to $10k, beyond which the credit manager, VP of credit, and other stakeholders get involved. This hierarchical approval ensures that significant credit exposures are carefully reviewed and authorized by those with appropriate oversight and decision-making authority.

How Is Credit Review and Risk Analysis Performed?

Credit review and risk analysis are essential processes in credit management, whether for existing or new customers. Here’s how credit risk analysis is typically performed:

For a new customer

• Credit application review: Through credit application, details about legal business name & address, any references (trade/bank), ownership information, Ship-to/bill-to information, other documents like W9, tax certificates, financial statements, etc.

  
  

• Credit agency data review: Obtaining and reviewing the customer’s credit report from credit bureaus. This report includes information on the applicant’s credit history, payment behavior, outstanding debts, and credit utilization.

  
  

• Financial data review: Companies also aggregate the customer’s financial data from public and private financials. Key metrics such as revenue trends, profit margins, and financial ratios are analyzed to assess the customer’s profitability and overall financial strength.

  
  

• Credit score review: Using a credit scoring model or system to assign a numerical score based on various factors such as credit history, payment history, credit utilization, and financial stability and assessing the customer’s credit risk level based on the credit score. This helps determine the likelihood of default or late payment.

  
  

For an existing customer

• Review of Payment History: Credit teams start by reviewing the existing customer’s payment history. They assess whether payments have been made on time and in accordance with agreed-upon terms. This historical data provides insights into the customer’s reliability and creditworthiness.
• Credit Scoring or Rating Updates: Some organizations use credit scoring models or rating systems to assign a numerical score or rating to existing customers. These scores may be updated periodically to reflect changes in the customer’s credit risk profile.
• Customer Relationship Assessment: Credit analysts consider the overall relationship with the customer, including communication, responsiveness, and past interactions. A strong relationship may indicate lower credit risk, while strained communication or unresolved disputes could signal potential credit issues.

The Role of Credit Managers in Credit Risk Assessment

Credit managers are part of the organization’s credit management department and are responsible for overseeing the process of granting credit to customers. They analyze financial data, evaluate creditworthiness, set credit limits, and manage risks associated with extending credit. 

An inappropriately high credit limit can put accounts receivable at risk, while an inappropriately low credit limit could result in a loss of opportunity to sell. Keeping this in mind, credit managers play a vital role in facilitating sales while minimizing potential losses from defaulting customers. Here are some of the responsibilities that credit managers take care of:

• Managing credit exposure: They monitor, analyze, and control credit limits and risks to minimize exposure effectively.
• Approving credit applications: They evaluate creditworthiness, set limits, and approve or decline credit applications based on risk assessment criteria.
• Reducing DSOs: They optimize billing, enforce credit limits, automate reminders, and offer discounts for faster payments to reduce DSOs.
• Creating collections Strategies: They develop and execute an effective collections strategy that includes regular follow-ups, escalation procedures for overdue accounts, and negotiation tactics.

Best Practices for Trade Credit Risk Management

Now that we know that effective credit management strategies are crucial for minimizing bad debt, improving cash flow, and building stronger customer relationships, it is essential to know them. To make it easier for you, here are some best practices for B2B credit risk management:

1. Carefully conducting creditworthiness assessment: Before offering credit to a customer, conduct a thorough credit check. Businesses must carefully assess the details provided by the customer to accurately evaluate the customer’s ability and likelihood to pay on time
2. Using the power of technology and automation: Utilize accounting and invoicing software that includes features for credit management, such as automated reminders for due payments, credit tracking, and reporting capabilities.
3. Monitoring customer payment behavior: Credit risk is associated not only with new customers but with existing customers too. So businesses must track payment patterns, identify overdue accounts early, and follow up promptly with reminders or escalation as needed to avoid any cash flow challenges.

3 Key Credit Management Challenges

If you are handling credit, you must be aware that credit management is challenging, and it’s crucial to understand these challenges. With that in mind, here are some key credit management challenges every credit team should be aware of:

1. Time-consuming customer onboarding process

Traditionally, credit applications are often paper-based and require manual data entry by the customer, leading to missing or incomplete business information. As a result, too much back-and-forth happens between credit teams and customers to capture the correct and complete information. This introduces delays in credit reference verifications and the entire customer onboarding process, which can negatively impact the customer experience.

2. Manual credit data aggregation, credit scoring, and approvals

Credit teams must manually download credit reports from D&B, Experian, and other credit agencies for each customer. This takes a significant amount of time and effort, particularly with large customer portfolios. Credit analysts must then manually review the credit ratings and financials and calculate the credit score. Thus, credit approvals become slow and tedious due to multiple stakeholders involved.

3. Lack of real-time visibility into portfolio risk

Most credit teams only conduct periodic credit reviews, making it difficult to identify at-risk customers promptly. However, the credit risk of a portfolio can change at any time. With thousands of customer portfolios, it is challenging to review and track frequent changes in their credit profiles regularly and involve significant manual intervention. Consequently, the credit team spends a lot of time on clerical tasks instead of focusing on core credit decisions. These challenges can lead to delays in credit approvals, increased risk of bad debt, and a negative impact on the customer experience.

How HighRadius Can Help Businesses Streamline Credit Management Processes?

HighRadius’ AI-based Credit Management Software empowers businesses to revolutionize their credit management process, enhancing financial stability. It reduces bad debts by 20% and improves credit application approval time by 90%.

Here’s how our solution helps businesses improve their credit-related risk strategies, reduce bad debt, and achieve long-term success.

1. Faster customer onboarding with online credit application

Our online credit application module significantly reduces onboarding time and effort. It is customizable for various customer segments and available in multiple languages, simplifying the application process. Pre-filled applications from the sales team further expedite customer submissions. Not only does this allow customers to complete the application quickly and easily, but it also reduces the chances of errors associated with manual information filling.

Automated credit report gathering and credit scoring

Our integration with credit agencies automates the capture of credit ratings, financials, and credit insurance details from over 35 global and local agencies in one consolidated process. Additionally, automating credit scoring and approval workflows can help credit teams fast-track credit decisions and improve the efficiency of the credit management system. Configurable credit scoring models can be customized based on customer segments or business units, helping credit teams make consistent and informed credit decisions.

3. Real-time credit risk monitoring

Our software enables real-time monitoring of customer portfolios. This feature offers credit teams immediate insights into credit profile changes, payment behaviors, and financial updates. Such proactive monitoring helps identify at-risk customers promptly amid economic fluctuations, enabling timely risk mitigation.

FAQs

1. What is credit management in O2C?

   
   

   Credit management in Order-to-Cash (O2C) involves managing the extension of credit to customers efficiently. It involves evaluating creditworthiness, setting appropriate credit limits, monitoring payment trends, and implementing strategies to reduce payment delays and defaults.

   
   

2. What is the objective of credit management?

   
   

   The objective of credit management is to ensure that a company extends credit to customers who can pay back on time while minimizing the risk of non-payment or late payment. It involves setting clear credit policies, assessing customer creditworthiness, and managing payment collections.

   
   

3. Is credit management the same as collections?

   
   

   No, credit management and collections are not the same. These are both different processes involved in O2C. Credit management involves deciding who to extend credit to and setting terms, while collections focus on obtaining timely payments from customers who have already been extended credit.

   
   

4. What are the different types of credit management?

   
   

   Different types of credit management include consumer credit management, which focuses on individuals’ creditworthiness; commercial credit management, which assesses businesses’ financial stability and payment capabilities; and risk management, which involves assessing credit-related risks.

   
   

5. What are the benefits of credit management?

   Credit management offers several key benefits to businesses:

   1. Improving Cash Flow: Ensuring timely payments enhances stability and liquidity.
   2. Reducing Bad Debt: Assessing and monitoring creditworthiness minimizes non-payment risks.
   3. Enhancing Profitability: Efficient practices lower financing costs and boost overall profitability.
   4. Maintaining Customer Relationships: Clear expectations and support foster positive client interactions.
   5. Proactive Risk Management: Identifying and managing credit risks minimizes financial losses.

6. What are the 5 C’s of credit management?

   
   

   The 5 C’s of credit management are character, capacity, capital, collateral, and conditions. These are key factors that lenders consider when assessing borrowers’ creditworthiness. They help evaluate the borrower’s ability to repay and the level of risk involved in extending the credit.

   
   

7. What are credit management skills?

   
   

   Credit management skills refer to a range of financial and analytical skills that enable professionals to assess creditworthiness, set appropriate credit limits, and manage credit risk. These skills include financial analysis, risk assessment, communication, negotiation, and problem-solving.

   
   

8. What is corporate credit management?

   
   

   Corporate credit management is the practice of monitoring and controlling a company’s credit and financial relationships with customers and suppliers. It involves assessing credit risks, setting credit limits, and managing accounts receivable to ensure healthy cash flow and minimize credit risks.