| Overview of a credit policy |
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| Tuesday, 11 May 2010 02:00 |
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1. Introduction When do you fi rst think of Credit Management? A lot of businesses start thinking of Credit Management when their customers stop paying! When the customer stops paying this is called Debt Management. So, what’s the difference! Credit Management, in broad but essential terms, is sound sales, backed by effective and efficient revenue collection resulting in profitable sales. Credit Management, in more detail, starts with a reliable Credit Policy. A Credit Policy should outline your company’s strategic and operational requirements from credit sales. It is not sufficient to provide credit to your customers “because everyone else gives credit”. You need to evaluate what your company needs from your credit sales i.e. •Increased Sales •Improved Profitability •New Customers •Increased market Share You can see that all of the above are driven with the aim of producing profitable growth, and not as a service to be abused by customers. So, you have decided why you want to offer credit to our customers (strategy) now we have to implement systems, procedures, limits, authorities and train personnel (operational) in the following areas: •Trading Terms •Vetting Controls •Credit Supply Limits •Invoice Management Control Software Some of you with the smaller businesses are probably thinking that you do not need to implement much of the above as you deal in small numbers. The facts are the smaller your business the more likely you are to suffer a bad debt. The reasons: •The larger companies have the better customers •The larger companies can choose their debtors •The larger companies have more resource to vet customers •The larger companies always vet their customers •The larger companies do not attract serial bad debtors •The larger companies have dedicated staff to deal with debtors I am sure that more can be added to the above list. The situation for the small business looks precarious: and it is! The sooner large company credit policy procedures are adopted the sooner you will have increased control of your company’s future. You must never feel that by insisting on every credit customer to follow your credit procedure that you are over doing it or that you risk loosing the sale through being ‘too careful’. Your trading terms say as much about your company’s unwillingness to suffer professional debtors as you could say in a thousand words. Do you include a Retention of Goods clause in your trading terms? Do you also clearly state when payment is due? Do you state that you will charge interest on outstanding invoices in accordance with the legislation promulgated in the National Credit Act? When vetting potential customers do you rely on any one piece of information: say, a credit reference report, or a bank reference, trade reference etc. If you use none of these, I suggest you do, and if you use only one, I suggest you use more. Do you ever ask for a director’s guarantee, if they refuse, draw your conclusions. Do you provide more than two months credit to any one customer, if so, you are more likely to suffer bad debt? A simple Credit Policy with manageable procedures will help build your business on minimum risk sales: these are the sales that are numerous and provide guaranteed profit levels. 2. Overview of Credit Control This overview concentrates on payment and debtors, as opposed to systems and procedures of accounting. If a Credit Policy has at its heart sound decision making, Credit Control has ‘control’. This point is often overlooked by companies that push every sale and ‘wait and hope’ for debtors to pay invoices on time. The ‘control’ does not start with receiving a delivery note, an order, or whatever procedure is used to notify credit control of a customers purchase. The control must start with a level of authorization/involvement in agreeing real-time credit limits and periods: sales staff sell and credit control, controls. The next stage of control is to raise an invoice a.s.a.p. and certainly within 72 hours: the invoice payment is controlled by a visual time limit, say 30 days, and your credit policy (which the customer has a copy of) sets out the conditions and penalties in respect of every invoice raised. Where possible, further control is established by calling the debtor after 48 hours to confirm: goods/service received, no problems exist, and invoice received and set up for payment. Where payment has not been received, to a maximum of 72 hours overdue, a call, a visit or letter (depending on industry and goods/service) is initiated to control and establish a new time-table for payment, say a further 48 hours. If after the extended period no payment has been received further action needs to be taken immediately: there is little point in saying “let’s wait and see what happens”, as nothing will happen. Another visit, a telephone call, or a letter that escalates your urgency is required at this stage to show the debtor that you still control the situation, if not the actual payment. You may suggest part payment now, the balance in 7, 10 days or even take some goods back (this option is not used enough in my opinion). If you have still not received the payment after one to one negotiation you have to accept you have a bad debt. 3. The Rules of Credit A Credit Policy exists, and is known, understood and accepted by all. Your Credit Policy should be an accessible document, resembling an induction manual, which gives ‘step by step’ instruction for the processing of credit applications. This need not be a large document that details every procedure in minute detail (ideal if you can), but it must have certain elements: •An application form with full details of procedure •Authority levels •Reporting structure for seniority •The administration procedure following a credit application In a detailed Credit Policy you would expect to find the complete system and procedure from the credit application through to bad debt recovery. Sales on credit terms drive sales, not support sales. You should only provide credit to your customers if you: •Can afford to •You get extra sales that you would not otherwise get •You can administer credit control and debt recovery functions You should not provide credit if you: •Cannot afford to •Get customers who want your credit more than your product •You have no experience or resource to administer credit Terms and Conditions of Sale/Service are disclosed to customers/clients and applied. Terms and Conditions say more about your credit function than any other action. You are telling your credit customers that standards are applied and, that any credit period allowed is a benefit you ‘choose’ to give, and not as a right of a trading relationship with you. Always send a welcome letter to new accounts with all their account, credit limit and payment details: why not get them to sign one copy to acknowledge the content? Ensure your sales people never say when talking to a customer/client “it’s OK, I can sort out a new credit limit for you if you need more goods/service”. Input of customer data is of a high standard. The administration of credit accounts, and your cash flow, can be seriously damaged if you cannot review all of your credit account details, such as, customer/client account reference, name and address, contact details, balances, arrears, current actions, new orders…. You must have more than faith in your staff and systems. Check your credit information regularly and improve constantly. Credit-check existing customers on a regular basis. Accept at an early stage that customers/clients will not be 100% honest with their financial standing. It is a human trait that we all describe credit as a useful tool, whether commercial or personal, in truth, for many of us it’s an absolute necessity. One or two financial checks per year are worth the time and effort only if you are prepared to respond to the results of the checks. Debtors are monitored to identify sales, creditor status and payment risk. A credit function will provide you with useful statistics that can be used as a sales tool as much as for risk analysis. When we talk of credit we talk in the negative, ‘make sure the limit is not exceeded’, ‘no more until they pay’ etc. But there is another way by positive credit vetting. If you allow a customer, say, R50, 000 credit limit, and they usually only take R25, 000, you are loosing out on a possible 12 x R25, 000 (R300k per annum): simple but true. If you can afford to provide credit to capture increased sales from a current customer who under uses a credit facility, go for it. The credit status of your customer/client should have a procedure where the level of their ability to pay is reflected in an updateable rating. If your customers are rated as A, B and C grades (A = low Risk, C = High Risk) you need a system to move their level up or down. The effect of this is to gear your business to satisfy grade ‘A’ customers/clients, where and when possible, ahead of other groups. Finally, the statistics over a period of time should provide you with payment trends that will reflect your customer/client yearly financial ups and downs. An obvious example being seasonal trade: almost every company has regular highs and lows. Payment terms are enforced and cash targets are set. Late payment by sixty days can wipe out the profit of a sale. A further sixty days can, with administration and finance costs, cost you 5 – 10% of the amount outstanding. Your payment terms should not be negotiable. If your customer/client does not have real funds to pay you, get THEM to overdraw or obtain funding from their bank. Your business is about your product or service, it is not your business to finance your customers/clients, without your agreement and/or having the cost of any such agreement fixed into the outstanding balance as compensation. A cash target is the catalyst of profitable trading, anything less than your target is an unacceptable burden. Your cash target should reflect your planning and budgeting needs. Targets have always been the focus on which credit controllers operate. Pro-active credit control and timely debt recovery Building relationships with customers/clients will allow you to get close to the operating principles they adopt. For example: if you know your customer/client is about to put in a large order and you do not think it prudent to allow that much credit, you could visit (best), telephone (will do) or write (if you have to) to the customer/client saying that you have heard rumours about…. and that some caution is required. With debt recovery you need to act immediately you know something. If the customer/client is one day late with their payment and you know of other suppliers who are having problems, there is little point in waiting for ‘a respectable period’ before getting serious with the debtor. All service, query control and complaints are a high priority. These three areas’ can sink any organization that lacks proper and measurable control. A R50k payment can be held up for a R10 query, a simple complaint, or for less than great customer service. Some companies have as much as half of their debtor balance tied up in situations that are avoidable, simple to rectify (at first), and destructive to ongoing sales. Your company must control your own cash flow and cost of money. With a debtor balance being one of the, if not ‘the’ biggest asset of a company, the need to understand and make your cash flow throughout your operation is paramount. A lack of financial knowledge and experience is arguably a company’s ‘Achilles heel’. A bookkeeper is not a luxury; they are an insurance policy if used correctly: with the gains far exceeding the cost. Money, as with any other commodity, costs money. If your customer/client pays late, it is your customer that dictates the cost of money to you. Maintain complete control at the start of a credit relationship, continue to monitor that relationship and reap the benefits of your work. 4. Credit Reporting Structure The credit reporting structure is notable in two ways: 1) The Credit Manager is accountable to the Finance Director, not the Sales Director 2) The Credit Manager has the same authority as the Sales Manager This credit reporting structure ensures the credit function has a clear route to the Managing Director without passing through sales. Sales staff cannot overtly influence credit decisions (as if they would). The Credit Manager and the Sales Manager have to work together. However, all problem areas can be resolved at director level, with a final level - Managing Director - to keep the peace. Ultimately, the success of the company rests on the relationship between sales and credit. 5. Terms & Conditions of Sale & Service When you gather all the necessary credit application information, you need to make a decision as to the viability of issuing credit to your customer. (The Credit Application is handled in the following chapter).  •Customer assessment (covered in the previous section). Company Reports are available to help assess a customers’ credit worthiness. •The terms & conditions you are willing to offer. •The credit limit you are willing to allow. Your terms and conditions are the most important element of credit sales. There are many books on contracts if you feel comfortable writing your own terms and conditions. You can start by looking at what other similar companies consider relevant for their business. However, an attorney is a must if you require terms and conditions outside of the basic 6, being: •Payment Period •Interest on Late Payment •Discounts •Notification of Queries and Complaints •Retention of Title •Legislation / Law When pursuing the discount option, you must be aware that it is: •affordable (to you the supplier) •profitable (after the discount is taken) •controlled (after the time indicated has lapsed, no discount can be taken) The supplier and the customer must both benefit from a discount. supplier’s benefits: •faster cash flow •can be used as a sales aid •reduced finance/bank charges •improved probability of receiving payment customer’s benefits: •genuine savings •improved margins •can off-set price increase •can negotiate higher discount rate for large orders Some companies enter the amount of discount allowed, together with the discounted balance. The problem with this is that the customer in seeing the discounted invoice total after the allowed period is always tempted to send you the reduced payment. It is not unusual for customers to take discounts even when paying 30, 40, 50 days late. You need to make your customer aware that you will not accept such action. Discounts are viable when you need fast cash flow, or have sufficient working capital, or your own financing is inexpensive. However, if you cannot afford discounts you must resist the temptation to do so, unless your customer wants a large order. Some customers would never consider paying late; therefore, by offering a discount you are drastically reducing your profit for a small gain in days. You should use discounts as a strategic option, be that to increase sales or improve cash flow. Once you start offering discounts, trying to stop them will seem like a price increase to the customer. In fact, after a short period the customer will not even consider the discounted price as anything other than normal with the following statement not uncommon, “I’ve always paid you in time for the discount, and now we have a few cash flow problems you want me to pay the full amount”, it happens, often. Notification of Queries and Complaints must be included in the terms and conditions as this clause prevents the customer from inventing queries or complaints as an excuse for non-payment. It also gives you an immediate opportunity to resolve any problem to the customer’s satisfaction, thereby, reducing the possibility of the customer requesting a refund. If your goods can be easily identified, you can recover your goods on default of payment. If your goods are low value and low volume, or form a small internal part of a larger manufactured item built by your customer, you are unlikely to recover your goods due to identification of your goods or viability of such recovery action. If you sued your customer for a breach of your terms & conditions of sale, and that the first time the customer had sight of your terms & conditions of sale were on the invoice, you may not be able to sue if your terms are anything other than basic. Your customer must be made aware of your terms and conditions of sale prior to delivery, and certainly before invoicing. You may be able to argue the terms & conditions of sale on the invoice were only reinforcing the verbal agreement between you both prior to the order (your word or theirs). The answer is to ensure you send the customer a copy of your terms & conditions of sale with your welcome letter. Further, send two copies of your terms & conditions of sale, and ask the customer to sign and return one of the copies. You can either print your terms & conditions of sale on the reverse of the welcome letter, or as a loose insert. After the initial sale, you could have your terms & conditions of sale on the reverse of your invoices, statements, etc. So, how does one put a credit policy together? We have included an example of a credit policy below. Please note that this is only a guideline and your business requirements and parameters will obviously affect the policy document. Credit Policy - A Credit Policy will essentially contain the following: 1. Main objectives of the Credit Policy What are you going to achieve by setting these objectives? These objectives are specifically relevant to the allocation of new accounts and credit limits, collection policies, legislation and staff advancement as well as skills training in and around the credit department but which would be aligned with the global objectives of the company. It would ultimately assist the credit manager in setting procedures and guidelines which will govern the credit function. Examples: To ensure that all monies that are due and payable are collected, within the terms set out by the Customer Trade Agreement, thereby reducing bad debt and increasing turnover, which is in line with the company’s overall mission of protecting shareholders investments and returning a profit. The Credit Policy can be used as a measuring tool to monitor credit control personnel’s performances and in the setting of Key Performance Areas for Credit Controllers. 2. Main Policy These objectives will ensure that the Policy encompasses all the guidelines of the department relevant to the performance of the staff and compliance with rules. Examples: To ensure that all credit control staff perform their credit function accurately and effectively, thereby avoiding losses in profit by minimising bad debt and slow payments, which restrict turnover. To assist the credit manager as a guide to do performance measurements on staff. 3. New Business You will now start policies regarding various areas of the credit business. List your policies and procedures in detail – remember, this policy can be used as a training guide for new personnel. Remember to include information regarding areas such as responsibility, approval levels and reporting functions. You can include the following: •Credit Vetting Process for new business •Approvals and Opening of New Accounts •Trade Agreements 4. Credit Limits & Payment Terms •Setting of Credit Limits and Payment Terms •Authorisation Levels of Credit Limit Approvals 5. Customer Master File maintenance and Filing of Documentation •Updating & maintaining Customer Details •Customer Correspondences •Authorisation Documentation •Credit Notes 6. Sales and Orders •Orders from Sales managers and Representatives •Telephonic and Faxed Orders •Capturing of Orders •Releasing of Orders •Cash Sale Orders •Invoices and Credit Notes 7. Daily Duties •Payments and Allocation •Re-printing of Documentation •Telephonic Correspondence with Customers •Updating the System with Daily Conversions 8. Collections •Month-end Invoices, Credit Notes and Statements •Projections and Target Setting •Follow-up on Non Payments •Reconciliation of Customer Accounts •Journal Processing 9. Claims •Customer Claim Documentation •Authorisation Levels of Claims •Return Claims •Pricing Claims •Short Received Claims •Discount Claims 10. Non-Payment and Default Customers •Reminder Letters •Stop Supply Notification •Account on Hold •Acknowledgement of Debt •Legal Action •Bad Debt Write-Off 11. Reporting •Daily Reporting •Weekly Reporting •Monthly Reporting 12. Customer Visits 13. Auditors Visit and Preparation  14. GeneralTo validate the Policy Document, the National Sales Manager, national Credit Manager and the Financial Director (or persons in similar or relevant positions) need to sign the document. This becomes a working document, to be distributed to the financial, credit and sales personnel in order that they all have an understanding of the Policy. |
| Last Updated on Tuesday, 11 May 2010 10:55 |