Credit Policy impacts DSO in a number of ways. One way is through Credit Standards. The Credit Standards you set will ultimately determine the risk you take with AR and the DSO your company will need to finance.
What are credit standards? Credit Standards in financial management are the guidelines used to determine a customer’s financial strength and ability to pay its obligations. They are used to control and manage risk to an acceptable level for your company. The financial factors considered in setting Credit Standards include:
Credit History
Customers that have a long and strong credit history are more likely to be good credit risks than companies that have little credit history or a poor payment record. A credit history review should include:
- Longevity – How long the customer has been sold on credit.
- Credit Amount – The largest amount of credit extended to the customer.
- Terms of Sale – The terms extended to the customer.
- Payment History – Has the customer payed according to the credit terms or payed late.
A check of credit history will help you determine the amount of credit and terms of payment that would be appropriate to extend to a customer.
Financial Resources
Customers with strong financial statements and good bank references are a better credit risk. They can weather business downturns and unexpected expenses with fewer problems. Adequate working capital and reasonable leverage help to ensure that a customer will pay according to terms.
Borrowing Capacity
Customers with the ability to borrow and a history of borrowing and repaying loans according to terms are better credit risks. Borrowing capacity provides an extra cushion for customers to draw on when business is slow or they have unexpected expenses. It is less likely that they will slow pay and use you to finance their cash flow.
Credit Terms
The amount of credit and terms of payment you extend should be appropriate for your business and for your customer. Don’t provide more credit than necessary or overly generous terms. This may encourage your customer to become over extended and increase the chance of late payment.
Collateral
Depending on the credit history of the customer and the amount of credit involved, it may be appropriate to obtain collateral such as a deposit or letter of credit to secure payment. Collateral is used more commonly in some industries than others. Be careful that you don’t become a bank for your customer, and over expand your DSO and get into a cash trap just because you have collateral.
Setting appropriate Credit Standards is an important element in controlling DSO. Tighter Credit Standards will reduce bad debts and DSO, but may also reduce sales and profitability. You need to find a happy medium where Credit Standards are adequate to support sales and maintain control over DSO.
A comprehensive approach to controlling DSO also requires the technology in automated accounts receivable and collections. Automation will give your AR team the resources to stay ahead of the curve on DSO.
The key to successfully automating accounts receivable and collections is to work with an experienced software partner.
Lockstep Collect is a market leader in cloud-based credit and collection platforms. Lockstep Collect can help you implement the technology applications you need to reduce and control DSO.
If you would like to learn more about how you can benefit from automating collections and accounts receivable, please contact Lockstep Collect at www.lockstep.io.
