Mastering Credit Management: A Comprehensive Guide to Financial Success

23 April, 2023
4 min
Bill Sarda, Chief of Staff, Digital Transformation

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Table of Content

Key Takeaways
What is Credit Management?
The Role of Credit Department in Trade Credit Risk Assessment
Steps in the Credit Management Process
3 Key Credit Management Challenges
Best Practices for Trade Credit Risk Management
FAQs on Credit Management

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Key Takeaways

  • Credit management helps businesses reduce the risk of non-payment and improve their cash flow to determine customer creditworthiness.
  • Real-time credit risk monitoring and regular portfolio monitoring are among the key practices for B2B credit risk management.
  • Adopting best practices, such as automating credit scoring and approval workflows, can reduce bad debt and improve long-term success.
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What is Credit Management?

Trade credit management is an essential process for suppliers to determine whether a buyer is creditworthy or not. Essentially, it involves analyzing the buyer’s ability to repay if they purchase goods on credit.

The supplier’s credit team typically assesses the buyer’s creditworthiness by reviewing various factors, such as their credit history, financial statements, and payment behavior. They then make a decision on whether to grant credit and, if so, what credit limit to set. Effective trade credit management can help businesses reduce the risk of non-payment and improve their cash flow.

The Role of Credit Department in Trade Credit Risk Assessment

Credit team has the important task of assessing the credit risk associated with extending credit to customers. This involves analyzing a customer’s financial history, payment behavior, and creditworthiness to ensure that credit is extended only to those who can repay it.

The responsibilities of effective credit managers include using credit limits as a lever to control credit risk and strike an optimal balance between sales and credit risk. An inappropriately high credit limit can put accounts receivable at risk, while an inappropriately low credit limit could result in a loss of opportunity to sell. Effective credit control, including credit analysis, credit limit setting, credit monitoring, and debt collection, is crucial to managing credit risk and ensuring long-term business success.

Steps in the Credit Management Process

The B2B credit management process steps are aimed at assessing credit risk, setting credit limits, and monitoring payment behavior. Based on the 5Cs of credit, here are the key steps involved in the credit management process:
Mastering Credit Management: A Comprehensive Guide to Financial Success

1. Review the customer's credit application:

For new customers, credit teams review the credit application to gather detailed business information, credit references, billing and shipping information, and more. The credit application acts as a consolidated record for the new customers. Existing customers may not require this step.

2. Review the customer's financial health:

Credit teams download reports from credit agencies to analyze the customer's credit ratings and payment scores. They also review public financial statements, such as cash flow statements, profit and loss statements, and balance sheets, to assess the customer's financial health. For existing customers, credit teams review the payment behavior along with 3rd party credit ratings and financials.

3. Ask for credit references:

Credit teams request credit references, such as bank and trade references, to verify the buyer's financial position and creditworthiness.

4. Calculate the credit score and credit limit:

Credit teams use sophisticated risk models to quantify the customer’s creditworthiness. These risk models are customized to the industry and the credit policy followed by the organization. Various parameters are used in these risk models, and they have different weightages across organizations. These parameters generally fall into the following buckets:
  • Financial Health – Income Statement, Balance Sheet, and Cash Flow Key financial ratios (some of them being industry-specific) are used in the model as financial health indicators.
  • Payment Behaviour – For existing customers, their payment history acts as a proxy for predicting future payment behavior. KPIs such as average days Late (ADL) is used to quantify payment behavior.
  • Operational Indicators – Age of business, length of relationship as a customer, number of employees, number of customers, etc.
  • Environmental Factors – Sometimes, it is essential to consider environmental factors such as the country of operation of the customer (factor in political and regulatory risk), the region of operation (if it is prone to natural calamities).
  • 3rd Party Credit Agency Rating – D&B Paydex score, Experian FICO score have relevant weightages in the credit scoring models.
Upon calculating the credit score, a credit limit corresponding to that score is assigned to the customer.

5. Get credit approvals:

Once the credit limit is assigned, it has to be approved by various stakeholders. For instance, a credit analyst might have the authority to approve credit up to $10k, beyond which the credit manager, VP of credit, and other stakeholders get involved.

3 Key Credit Management Challenges

Credit management involves several challenges that can impact the efficiency and effectiveness of the business credit management process. Here are some key credit management challenges encountered by credit teams:

1. Manual customer onboarding impacting customer experience:

Credit applications are often paper-based, leading to missing or incomplete business information. This results in multiple interactions between credit teams and customers to capture the correct and complete information. Slow credit reference verifications further delay the customer onboarding process, negatively impacting the customer experience.
51% of credit managers struggle with obtaining accurate and up-to-date financial data

2. Manual credit data aggregation, credit scoring, and approvals:

Credit teams must manually download credit reports from D&B, Experian, and other credit agencies for each customer. This takes a significant amount of time and effort, particularly with large customer portfolios. Credit analysts must then manually review the credit ratings, financials, and calculate the credit score. Thus, credit approvals become slow and tedious due to multiple stakeholders involved.

3. Lack of real-time visibility into portfolio risk:

With periodic reviews, credit teams struggle to identify the at-risk customers. The credit risk of a portfolio can change at any time. With 1000s of customer portfolios, it is difficult to regularly review and track the frequent changes in their credit profile. The majority of credit operations involve a lot of manual intervention. As a result of this, the credit team dedicates a lot of time to clerical tasks instead of the core credit decisions. These challenges can lead to delays in credit approvals, increased risk of bad debt, and a negative impact on the customer experience.
Mastering Credit Management: A Comprehensive Guide to Financial Success

Best Practices for Trade Credit Risk Management

Effective credit management strategies are crucial for minimizing bad debt, improving cash flow, and building stronger customer relationships. Here are some best practices for B2B credit risk management:

1. Faster customer onboarding with online credit application:

Implementing a configurable online credit application can significantly reduce the time and effort required for customer onboarding. Online credit applications can be customized based on customer segments and configured in multiple languages. Pre-filled credit applications from the sales team can further streamline the process, allowing customers to complete the application quickly and easily.

2. Automated credit scoring and approval workflows:

Automating credit scoring and approval workflows can help credit teams fast-track credit decisions and improve the efficiency of the credit management process. Configurable credit scoring models can be customized based on customer segments or business units, helping credit teams make consistent and informed credit decisions.

60% of businesses are increasing their investment in credit risk management technology to improve the efficiency

3. Real-time credit risk monitoring:

Regular monitoring of customer portfolios can provide credit teams with real-time visibility into changes in credit profiles, payment behavior, and financial filings. With significant macroeconomic fluctuations, regular monitoring can help credit teams identify at-risk customers and take timely action to mitigate credit risk.

By implementing these best practices and leveraging technology solutions such as HighRadius’ AI-based Credit Risk Management Software, businesses can improve their credit risk management processes, reduce bad debt, and achieve long-term success.

Streamline your credit management process with HighRadius' real-time credit visibility and automated workflows

FAQs on Credit Management

1. What are the benefits of credit management?

Credit management is a crucial aspect of financial management that helps businesses maximize cash flow, minimize bad debt, and build stronger customer relationships. Effective credit management enables businesses to assess the creditworthiness of customers, set appropriate credit limits, and manage credit risk.

2. What are the 5 C’s of credit management?

The 5 C’s of credit management are character, capacity, capital, collateral, and conditions. These are key factors that lenders consider when assessing the creditworthiness of borrowers. The 5 C’s help lenders evaluate the borrower’s ability to repay the loan, the level of risk involved, and the terms of the loan.

3. What are credit management skills?

Credit management skills refer to a range of financial and analytical skills that enable professionals to assess creditworthiness, set appropriate credit limits, and manage credit risk. These skills include financial analysis, risk assessment, communication, negotiation, and problem-solving.

4. What is corporate credit management?

Corporate credit management is the practice of monitoring and controlling a company’s credit and financial relationships with customers and suppliers. It involves assessing credit risks, setting credit limits, and managing accounts receivable to ensure healthy cash flow and minimize credit risks.

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HighRadius Credit Software automates the credit management process, enabling credit managers to make highly-accurate credit decisions 2X faster and enable faster customer onboarding with 4 primary components: configurable online credit application, customizable credit scoring engines, credit agency data aggregation engine, and collaborative credit management workflow. Along with that, there are a lot of key features that should definitely be explored some of which are online credit application, credit information aggregation, automated credit scoring & risk assessment, credit management workflows, approval workflows, and automated bank & trade reference checks. The result is faster customer onboarding, better internal collaboration, higher customer satisfaction, more targeted periodic reviews, and lower credit risk across the company’s customer portfolio.