Is Periodic Credit Check Healthy?

When I wrote my article on “Is collection a Rocket Science?”, I got some good insightful inputs, and few expressed that Credit and Collection is a Rocket Science. Yes, Credit surely is an art and a science!. Credit Management is all about people & processes. It is more complex varying widely from industry to industry. Many aspects needs to be considered while granting credit, as we are building a strong relationship with customers and expect to carry forward for years to come. It is extremely imperative to know your customers thoroughly before granting credits or dealing with them.

So what do we need to look at when we are granting credit to any customers? Well the requirement can change from customer to customer. Managing credit is dynamic because each customer is different and so are their processes, however a strong credit policy catering to various customers is the key.

Some of the aspects of credit Management will include Processing the Credit Applications for new customers based on their credit worthiness, repayment capacity, size of the company, years in Market; Conducting the credit Investigations and managing the credit granting process; Analysis of Financial statements; Making commercial decision through proper due diligence; Identifying the appropriate Payments terms, especially document related like Letter of Credits; Execution of new orders for existing and overdue customers: DSO Management; Protecting customers through Credit Insurance depending on the volume of the business and risk appetite;  Credit Department Audits; Identifying warning signals; Period Credit Assessments - most importantly. There could be many more processes besides those mentioned here.

I would like to emphasize on the importance of the periodic credit assessments, which will state about the customer behaviors over the years, their current financial health, any changes in the payment patterns, default history, changes in Organization, any red flags alerts and more.

Many a times, a complacency sets in when things are going good, when the going gets tough the reality hits hard and by the time we try to do the damage control, the storm could have crossed over. Recently have been reading about the appalling instances of financial defaults running into huge losses, clearly indicates that there could be lack of regular health check on the credit status of the customers. While saying this, it is not only customers that we are lending to should be given focus on the financial health of their customers on a periodic basis, Even investors need to be careful where they are parking their money through regular assessment of the growth and market status of the company they are investing. Anything unusual is always an alarm be it change in the delay in payments, DSO changes or significant movements in the Organization.

So what are the signs that could bell a warning signal? The signals can be both internal and external. Internally Major issue or challenge can arise from the reluctance and resistance from people within the Organization. External warnings could be:

·      A recession

·      Customers Profit margins tightening

·      Payment terms not kept

·      Receiving part payments or post-dated cheques

·      Cheque bounces

·      Calls avoided by customers or frequent change in staff

·      Increase in DSO period

·      Excess Inventory levels

·      Increase in bad debts

·      Attrition or Significant turnover in the Management level, to name a few

Period credit checks will bring any red flags for immediate attention to take necessary actions. In one of the Organization I worked in the past, we would collect renewed trade license on a yearly basis, this was a key action for us to identify customers that had run out of business or the customers that were facing problems with their businesses and raise the necessary alarm for corrective action.

“He who does not economize will have to agonize” – Confucius. In this context it is better to be have regular periodic credit checks, like yearly health checks, then to face unexpected and huge losses.

Please share your thoughts and add to the list of the warning signals you have come across.