For B2B businesses, credit management is essential for accounts receivable (AR) management success. Proper, healthy credit management allows for steady cash flow, better collections management and a manageable days sales outstanding (DSO).
As businesses evolve to operate physically and virtually, credit management has become critical to a business’s financial success. Due a varying array of economic factors, delayed payments, and cash conservation. Because of these factors, traditional credit rating systems have become less reliable. Procedures for granting credit and setting credit limits are often out of sync with the realities of how businesses operate today.
The Credit Research Foundation estimates that only 20% of credit departments have formalized policies. Be it lack of critical financial information, undue to time constraints, or higher priority projects, many companies, today, struggle to create formal credit policies.
Many companies need to revisit the way they handle credit management. Although traditional methods of credit management can still be used, they should be paired with other best practices to protect your company from cash flow risks. In this white paper, we will teach you the basics of credit risk management and how you can make better, faster decisions about extending credit to customers by leveraging modern tools and tactics.
The Basics of Credit Management
The longer an invoice goes unpaid, the less likely it is that the invoice will ever be paid in full, or at all. Today, the average company’s AR positioning looks like this:
- 39% of invoices are paid late.
- 17% of customers do not adhere to credit terms.
- 48% of customers delay payments.
- 52% of businesses ask for extended payment terms.
- Average DSO is 61 days, more than two times the average payment terms (28 days).
By implementing best practices and proven tools to help you identify and reduce credit risk, you can change those numbers, and start putting your accounts receivable assets to work. Credit management should start with a sound policy that addresses the framework of how to manage credit including:
- Risk: The amount of bad debt losses and credit exposure that is consistent with your company’s goals, policies, and internal “comfort levels.”
- Approval Process: Your set guidelines for approving credit.
- Credit Limits: The maximum amount of allowed credit and process of determining this limit.
- Credit Terms: An agreement between buyer and seller regarding the timings and payment to be made for the goods bought on credit.
With uncertain business conditions, new approaches may be needed to deal with each of these elements.
In any economic situation, your risk constitutes the amount of bad debt losses and credit exposure that your company is willing to forego, if AR is not paid timely. In today’s uncertain economic climate, with inflation and recession occurring simultaneously, risk appetite should be assessed often. Establishing and adjusting risk tolerance is essential to a successful credit risk management strategy.
Undoubtably, your approval process should be reviewed and revised for several key reasons, including:
- Increased risk for certain industries and companies.
- Credit reports, which inherently have many drawbacks, may be unreliable.
- Bank and trade references may be of limited value due to rapidly changing business conditions.
- Company financial statements and ratio analysis may be based on outdated information.
Credit approval is typically based on historical information, which is of limited value in a rapidly changing economy. It may be necessary to rely on anecdotal information from conversations with banks, suppliers, and competitors until the economy recovers.
While nearly 60% of U.S.-based B2B sales are paid using customer credit, knowing how much credit to extend to which customers is of dire importance. Issuing too much credit to the wrong customers can lead to disastrous outcomes. It is advisable to reduce or eliminate credit limits for riskier customers. Now is a good time to visit all customers for a credit review.
Many companies offer credit terms common to the industry they are in. This may no longer be advisable in the current economic environment. You may need to offer alternative terms to riskier customers such as shorter payment terms, cash discounts for early payments or other key incentives for customers to pay on time.
Important Note: Make sure there is buy-in from all stakeholders before changing a customer’s terms. When communicating with customers, include these stakeholders to immediately answer any anticipated questions.
Leveraging Tools and Technology to Monitor Credit Risk
Monitoring credit risk is done more efficiently and effectively with automated credit and collection solutions. Sage AR Automation has a number of solutions which can help you monitor credit risk including:
- Custom Credit Scoring Model: Calculates credit score based on values and weighting assigned to factors you think are the best indicators of your customers’ credit quality.
- Dashboard Reporting: With a glance your team can see a customer’s account status, custom credit score, days past due, available credit, D&B, Experian, TransUnion; and whether the account usually pays on time or late and by how many days.
- Automated Customer Communications: Automated emails or text reminders based on the status of customer invoices.
- Activity Management with Smart Activities: Prioritizes activities for your team based on account information.