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What is credit management and why is it important for risk mitigation?
Blog //11-08-2022

What is credit management and why is it important for risk mitigation?

by Daniel Docherty, Director of Strategy

Credit is essentially any money coming into a business, either now or at some point in the future. This could be cash that is paid in by lenders (such as banks), shareholders, or other investors. Or it could be a payment that is owed by a customer once a sale has taken place.

If finance teams don’t manage credit appropriately, it could impact their bottom line in a negative way. In this article we explain exactly what credit management is and why it’s so important. We also highlight the associated risks of neglecting this activity and the benefits gained from doing it well, while also giving our top tips on how to improve your credit management process.  

What is credit management?

Credit management is the activity of determining reasonable credit terms and then collecting payments when invoices are due. It’s important for there to be an ongoing connection between sales and finance activity, to reduce risk as much as possible and to keep credit-related data accurate.  

It is common for B2B companies to buy and sell on credit, because this can be an effective way to improve existing partnerships and to forge new ones. It’s a useful method for getting sales over the line too, as customers can be attracted by not having to pay right away. It’s also seen as a convenient way to trade, as businesses can work around their preferred timescales.  

The financial health of your company may be dependent on finding ways to avoid late or missed payments. Customers that are prone to these scenarios can threaten your business’s prosperity if left unchecked. However, it can be difficult to analyse new customers and track existing ones in terms of their creditworthiness.

Financial struggles among small-to-medium-sized businesses are in many cases caused by a failure to ensure invoices have been paid. Larger companies are perhaps better equipped to deal with these losses, but it will still impact their profitability and growth.

What are the risks of poor credit management?

Cash is the lifeblood of every business. If you're spending money on resources but not receiving payments from customers, sooner or later you'll hit a bump in the road - and that bump may be a threat as significant as liquidation.

Keeping your business afloat may require a large overdraft or loan, that you wouldn't otherwise need if customers paid on time. You will be charged interest on any credit extended from a bank, which eventually becomes an additional expense. As a result, it may become difficult to pay suppliers if there’s no liquid cash flowing through the organisation. These negative outcomes can be minimised simply by employing some effective credit management procedures.

What are the benefits of effective credit management?

  • Minimise risks

Having a clear picture of your company's finances is one of the most beneficial aspects of credit management. With clarity you can avoid unnecessary credit risk and take advantage of previously unseen opportunities.

By continuously assessing income and expenditure, it’s easier to take actions that ensure the incomings are exceeding the outgoings. As a result, it’s far more likely that payments such as bills and salaries can be paid on time.

  • Avoid late payments

Bad debts can be prevented, and the number of late payments made by customers can be reduced by detecting them earlier. This also reduces the likelihood of your company experiencing adverse effects as a result of a default.

  • Increase liquidity

An asset's liquidity refers to its ability to be converted into cash simply. Stable and consistent income from customers is one of the main sources of healthy liquidity for businesses.

  • Better debt recovery

Debt recovery can be completed in a much smoother manner, at a much faster rate, and with as little effort as possible, while also ensuring none of the debt is missed. There’s also less tension between the payer and payee.

  • Enhanced reputation among lenders

Lenders are more likely to look fondly on businesses that have efficient methods for retrieving the credit they are owed. And these lenders will be more willing to provide credit to those that can demonstrate healthy cash flow.

How to improve your credit management

  • Implement a dedicated credit management process

As soon as you partner with a new customer, you should ensure the terms of your agreement are clear. It is important that all terms relating to payments are outlined to ensure financial transparency. They should not only be clear to customers, but they should also provide a basis for your finance team to follow. If a late payment issue arises, make sure your policy clearly states your tolerance and the actions you can take.

  • Set responsibilities

Once a credit management procedure is in place, you should continuously analyse it to ensure it still functions. You should also ensure all related responsibilities have been delegated to the appropriate people. Who is the central authority for credit management? Is there a dedicated team, or perhaps just a single person? Does this person have enough time to be accountable for these matters? It’s important to assign roles to the right individuals, who also happen to have enough capacity.

  • Analyse new customers thoroughly

When taking on new clients, be sure they do not become a liability, by creating a credit risk mitigation plan that identifies and assesses their risk of defaulting on payments. Recurring reviews should be conducted for existing customers too. It’s not guaranteed that a customer will never default simply because you’ve had a good relationship with them up until this point.

  • Invoice customers immediately

Your credit control process can be significantly improved by invoicing quickly and accurately. Confirmation of receipt should be requested as soon as a customer has been invoiced, as this can help to eliminate problems before they arise.

  • Send reminders in advance

It is not unheard of for invoices to be paid late for simple reasons, such as the responsible employee being on annual leave. You can prevent these issues by sending a reminder in the week or two leading up to the due date.

  • Log all credit-related activity

It is crucial to keep a record of your communication with customers in case questions arise about payments. How can finance recover the original invoice if it is lost? What if the person who made the purchase leaves the company? In the event of a dispute, keeping a record of all correspondence ensures you have the necessary information at hand.

It is very common for us to think negatively about debt collection. Credit management doesn't have to undermine your relationship with customers. You can ensure effective credit control by building a strong relationship with clients and maintaining clear methods of communication.

  • Use credit management software

Using dedicated technology to assist with credit management is one of the best ways to achieve the above points. By using a digital system, elements of the credit management process can be automated. Invoices can be sent automatically following a sale, and prospective clients with a poor credit record can be flagged instantly. With all correspondence stored in a software solution, businesses can easily call back upon events if a customer challenges a particular policy.

Which credit management software to use

At Advanced, we provide a Cloud-based accounting solution called Advanced Financials. This system has dedicated functionality for end-to-end credit management, allowing finance teams to manage every element of the credit management lifecycle.

Sales invoices are automated leading to saved time and generally better efficiency. This makes debt retrieval as stress-free as possible, improving the flow of cash through the organisation and reducing credit risk.

Not only this, but as it is an all-encompassing financial management system, all financial tasks are processed and stored in one location. So, any credit that is due to be received, along with expenditure and all other financial data, influence one another, giving finance teams and managers a view of the bigger picture and overall financial health.

This data feeds the built-in reports and dashboards, driving transformational decisions and tactical changes. As it’s Cloud-based, this data will always be as accurate and current as possible, as updates can be made from any place and at any time.     

 

If you’re looking to implement an effective credit management strategy to minimise credit-related risks within your business, be sure to read more about our Cloud-based accounting software.

Blog Advanced Financials Financial Management
Daniel Docherty

Daniel Docherty

PUBLISHED BY

Director of Strategy

Daniel joined Advanced in May 2019 to lead our Software as a Service portfolio, moving on to lead the overall Finance Management, Spend Management and People Management strategy. He brings over 18 years of experience in core business and finance solutions, working with customers from a wide background of industries and scale.

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