Credit risk management is an important element of the proper company’s operations. The process can be shown as a series of four phases:
- Defining the criteria and policies of the credit risk management with the development of procedures and tools for its implementation,
- Analysis of customers and their environment, combined with the choice of instruments of credit risk mitigation and receivables management tools, → more
- Monitoring of the current risk (of the receivables), → more
- Collection or recovery of difficult receivables. → more
FUNDAMENTALS: Defining the principles of credit risk policy with the development of procedures and tools for implementation
Credit policy should be more than just a collection of indications for technical debt management. Properly defined can be a point of reference for the entire company (not just the finance department) on the financing of sales. Well-written, comprehensive credit policy is also helpful in the day-to-day dialogue with customers. Policy determines and formalizes the operational objectives of the company, determine the scope of rights for granting the trade credit, define expectations and responsibilities, as well as improve cooperation with other departments of the company, especially sales.
When building the credit policy, you must remember about those tree rules:
- The fundamental goal should be maximizing the profit and not minimizing the level of past due or bad debts. The choose between those two options depends mainly on gross margin. In case of high profitability, more liberal (generous) credit policy is recommended. The focus on reducing the past due and bad debts should be more important in case of low margins.
- The attention should be intense on risky customers. There is no need (and in most of the cases – no time) to spend the same amount of time analyzing all customers’ accounts. If the credit application is about low amount, the decision should be more routine, fast, based on limited data. For big contracts or large accounts, the analysis should be more in-depth, involving all possible financial and non-financial factors.
- You should think long-term. The credit decision is a dynamic process. You must not focus only on what is now, or what the financial standing of the customer was in the past. This is what we can in the financial statements, can’t we? Sometimes it is worth to accept higher risk on the condition that considered customer could become a very important and strategic account. That is why, the newly established companies should be prepared to accept more bad debts than those with long record on the market.
One cannot achieve those goals without the following:
- having discount policy in place for its customers
- credit assessment system for all customers
- credit risk mitigation strategy and tools
- receivables collection policy and procedures
→ Effective credit policy - is it worth to have that? [CreditBlog]
→ Credit policy [CREDITOPEDIA ©]
→ Credit procedures [CREDITOPEDIA ©]
→ Credit controls [CREDITOPEDIA ©]
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