The Importance of Credit Management

januari 7th, 2013 · by John · Weblog EN

One of the most, if not the most, important activities in your company is credit management. Credit management is the process to ensure that customers will pay for the products delivered or the services rendered. Credit management is of vital importance to your cash flow: you can be profitable, but if you lack the cash to continue your business, you will either be bankrupt or taken-over by someone who knows how to deal with cash.

Customers that have not yet paid are called accounts receivables (AR). The problem with AR is that this is money owned by your company (AR is also called debtors!) over which you do not have any control. There are two huge disadvantages with AR.

  • As long as your client has not settled his amount due, capital remains tied in AR and does not even carry interest. Capital is cash, and you can use that cash for many other, far more useful and profitable purposes.
  • As long as an amount is outstanding, there is a risk that the customer will not be able to pay. The longer it takes the customer to pay, the higher the risk of non-payment. Non-payment or bad debt means a loss of 100% on that account.

At first glance the solution is simple: do not extend credit to customers. If a customer wants to purchase something from your company, tell her that she should either pay in advance or pay at delivery. In that way you will not have AR, meaning all your cash is ready available and you do not run the risk of bad debt.

If life were only that simple! The problem is that in many cases where you decide not to extend credit, the customer will go to competition. This makes credit management not only an important process, but also an interesting activity. In all your dealings with a customer you will have to weigh two risks: (1) the risk of late or non-payment, and (2) the risk of losing the sales.

Again this is easier said than done. Credit management is not only an important and interesting activity, but also an extremely difficult job. In future blogs I will therefore discuss in somewhat more detail the three important steps in the credit management process:

  • Reviewing credit worthiness and deciding whether or not to extent credit.
  • Monitoring amounts that are not yet due, but on which you nevertheless run the risk of late or non-payment.
  • Collecting the cash of amounts that are past due, but have not yet been settled.

John Greijmans

 

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