Credit Management is a branch of financial management, and is a function that falls under the label of “Credit and Collection’ or ‘Accounts Receivable’ as a department in many companies and institutions. They will usually deal with the credit vetting of customers, the resolution of any invoice queries or disputes, allocations of payments or cash application, internal fund movements, reconciliations and also maintaining positive working relationships with the customer during the debt collection or credit review and approval process.

A key requirement for effective revenue and receivables management is the ability to intelligently and efficiently manage customer credit lines or credit limits. In order to minimize exposure to bad debt, over-reserving and bankruptcies, companies must have greater insight into customer financial strength, credit score history and changing payment patterns. Likewise, the ability to penetrate new markets and customers hinges on the ability of a company to quickly make well informed credit decisions and set appropriate lines of credit.

Credit Management has evolved now from being a pure accounting function into a front-end customer facing function. It involves screening of customers and only those who are credit worthy are allowed to do business. A sound review of the financial position of the
customer, and understanding of their business model is the first step in ensuring that the company does not end up selling to a customer who ends up seriously delinquent or in default.

Hence, before the sales function commences its business with the particular customer, the credit management role begins. Later as the customer starts dealing with the company, the accounts receivable function is used to ensure recovery as per agreed terms of credit is followed.

For many years credit was considered a necessary evil in business. Over the years, many individuals and institutions within the arena of the credit industry have fought to change this opinion. More recently, the word “credit” has become synonymous with business internationally, with the global credit crunch; the sub-prime disaster in the USA; the
collapse of many established banks worldwide; recession and locally in South Africa, the introduction of the National Credit Act.

These situations have succeeded in highlighting the importance of credit control and in many areas of industry has become one of the major successes in business today. In South Africa, billions of Rands are made daily to customers who promise to make later payments in accordance pre-arranged agreements, which results in the need for professionally qualified personnel to liaise with the sales department, control the debtors’ function and ensure the cash flow of the company. Success in these areas of the business leads to an increase not only in the volume of the business, but also in the profitability of the enterprise.

The definition of credit can be understood as:
“Credit is the use of goods or services now, in exchange for a promise to pay at a later agreed date.”

The fundamental and basic principles of credit apply throughout business, but due to the diversity of businesses both nationally and internationally, there are also many applications of credit which may apply to some areas of business and not to others. What the individual businesses need to understand is what works for them and their customers (the debtor); as well as to have a good understanding of what applies to them with regards their creditors. The risk of bad debt may threaten the business, whereas overspending could lead to sequestration or liquidation. South Africa has gone through huge changes in the last twenty years and continues to battle politically, economically and socially with its past and present. Added to this is the population growth, technology, inflation and interest rates which will all have an impact on the way in which we conduct business today. Business environment is constantly changing and evolving to absorb these changes and is both exciting and challenging. Business owners, shareholders, directors, managers and staff need to be able to adapt quickly and positively, otherwise success will be extremely difficult to achieve within the current climate. Most of these factors need to be taken into consideration when granting credit, not only to new customers, but also to long established customers. It is in times like this that any company whose sales and credit departments are unified in their objectives will in all likelihood be more flexible, profitable and succeed in their venture.

In simple terms, by making credit services available, individuals are able to improve their “standard of living”. We are then able to take possession of goods or services, immediately and thereafter pay for such goods or services at a predetermined time. These transactions take place between individuals, in spite of the fact that the seller or provider of the credit service may be employed by a firm. The decision whether to extend or deny credit services rests with an individual; likewise the decision whether to utilise or ignore the existence of credit services is an individual choice. Freedom of choice is therefore an
essential element in the granting of credit services, enabling people to avail themselves, of this service, to choose from a number of alternatives. The market availability, in a free economy, determines not only the choice of the article which is required to satisfy a specific need, but also from where or from whom the article may be obtained. This choice also includes whether the article will be paid for immediately, or if credit facilities will be applied for the purchase of the goods, with a promise of payment at a later date. The supplier of the goods or service also has the freedom of choice whether this will be given away, sold for cash or sold on credit. It is also at the supplier’s discretion as to who may be granted the privilege of being offered credit facilities. This is “consumer credit”, the supply of goods and services to a natural person for personal consumption. The same will apply for “corporate credit”, granted between one business and another, obviously with alternative and specialised policies and procedures. Thus the credit environment is established, and documented proof of the transaction is catalogued and payment by the other party is deferred to an agreed future date.

Any business needs to weigh up the advantages or the disadvantages of credit, and the role that it will play within their business plan objectives, in order to ensure the success of the venture. If credit is to play ANY role in the business, then it is necessary to ensure that the correct policies and procedures are in place. This is vital when documenting a transaction, specifically when there is a default in the payment terms. There are a number of areas within the legislation of South Africa that apply to any area of credit granting, corporate governance and individual rights that can make credit control a business nightmare if the correct policies and procedures were not implemented from the beginning. This highlights the necessity for a professional to handle the credit function within the business.

Any business embarking on a venture needs to investigate the pros and cons of getting involved in credit. In a country like South Africa, credit is an integral way in which we do business, and many businesses need to investigate their options when trying to break into the big time - government contracts, corporate contacts, etc. It is also imperative to ensure that the person/s handling this area of the business are skilled and competent, having knowledge of the rules that apply to the profession of credit.

The advantage of credit is that it multiplies the volume of business, and if granted judiciously, increases profit. The risk of bad debt however, may reduce the profitability of the business. It is a convenient way to increase the capacity of the business without draining its financial resources, but because credit is readily available to a creditworthy business, overspending becomes a possibility and this leads to liquidation or equestration. Credit allows a consumer / business to purchase goods and services now and defer payment until a later date and in convenient instalments; whereas, depending on the cost of money, buying on credit could be costly and inflationary. Instruments of credit (cheques, electronic payment, credit cards, bills of exchange, etc.) can be used to pay for transactions, saving time and the risk involved in drawing large amounts of cash to pay for goods and services. Any increase in the bank rate is passed on to credit users. This could have serious cash flow problems for the credit receiver. Then there is the discipline of meeting ones commitment on time to create a good credit record which contributes to high business standards. There are, however, costs involved to supply a credit service – a credit department with capable staff, credit management systems including computers, which are expensive. However, there are outsourcing alternatives which are dealt with in this publication.

South Africa is fairly well regulated society, as we are within the credit community. The National Credit Act is one such legislation that was introduced in order to ensure that the rights of both the grantor and receiver were taken into consideration. It is an act which is designed to protect the consumer and allow them to make more informed choices before buying goods and services on credit. It also places a greater responsibility on the credit providers to refuse to give credit if the consumer cannot afford it and, for the first time in South African history, the National Credit Regulator it will regulate the way credit providers do business. No other country has brought in such far-reaching legislation because they have allowed market forces to determine initiation fees and interest charges.

There are of course, many other areas of legislation that cover business and credit management which are discussed in a later chapter in this journal.

The basic definition of credit control is: Policies aimed at serving the dual purpose of (1) increasing sales revenue by extending credit to customers who are deemed a good credit risk, and (2) minimizing risk of loss from bad debts by restricting or denying credit to customers who are not a good credit risk. Effectiveness of credit control lies in procedures employed for judging a prospect’s creditworthiness, rather than in procedures used in extracting the owed money. If your business has skilled staff to maintain the credit function with access to all the readily available credit information, with sound policies and procedures in place, then this department will contribute positively to the business’s cash flow and profitability. If not, and the credit department is still viewed as an obstruction to sales and a collection agency within the company, then there is the potential for a disaster waiting to happen.

What is vitally important is to realise the advantage that an effective and efficient credit team will have for your business.