Managing Credit: Is your Credit Policy Profitable?

"Credit has done a thousand times more to enrich mankind than all the gold mines in the world. It has exalted labour, stimulated manufacture, and pushed commerce over every sea" Daniel Webster

Puru Grover,
Manager, Business Education: Dun & Bradstreet

Credit is an indispensable catalyst in financing the movement of commerce. Its roots go fairly deep in time and are definitely as old as the concept of trade itself. As early as 1300 BC the Babylonians were lending on the basis of getting a charge on security or collateral. Credit touches us in various ways. To some it could be a mere caress or a tickle, to others it could be a brush, to some a graze and for others a crash or a collision.

To demonstrate the importance of credit, according to Industry Canada sources the Small Business Loans Act (SBLA), a program that serves start-up and smaller firms, has succeeded in lending more than $ 20 Billion to over 50,000 Small and Medium sized Enterprises (SMEs) in Canada, since its inception in 1961. The loans have helped in creating approximately four new jobs per loan. Today SMEs have become an integral part of the Canadian economy. Firms with fewer than 50 employees each were responsible for 81% of the new jobs in Canada in 1996-1997.

Credit helps in production, distribution, selling, consumption and expansion. It helps smoothen the rough curve of seasonality of a seasonal business. It increases the immediate buying power of a consumer. But where there is good there may also be bad and ugly. Credit could mean a collapse due to Overbuying, Overexpansion or Overselling.
Probably the single most important factor is the maintenance of proper cash flow in operating a successful franchise. Cash flow problems can be avoided by making sure that you administer and manage credit with financial prudence and get paid promptly for goods or services rendered. Accounts Receivables, which can be broadly defined as uncollected sales, are one of the largest assets of a business, amounting to approximately 15% to 20% of the total assets of a typical manufacturing business. An uncontrolled growth in sales could result in an uncontrolled management of account receivables.
What is the mission of a person with credit responsibility? What is the function of credit and credit management? To answer these questions I will refer to an article written by Michell Woods-Howell, wherein is mentioned the mission statement of Microsoft's Credit department. - 'To maximize the protection of Accounts receivable while supporting Microsoft's effort to expand sales and increase market share throughout the world, to evaluate accounts receivable worldwide risk and to make sure we have appropriate reserves in place.'

It just goes to corroborate the fact that no matter how big or small is the size of business operation, companies are focussing increasingly on managing and collecting their receivables efficiently and effectively, thus maximizing their cash inflows.

Credit is temporary capital and the objective of credit is to lend with the purpose of increasing profits and sales. A sound credit policy in business is the blue print to managing by measurement and benchmarks. The question then arises is 'What is a Credit Policy and how does one write a Credit Policy for their specific nature of business operations?

Writing an effective Credit Policy begins with an understanding of the financial exposure that you or your business can endure and the amount of your working capital that you would be willing to risk, or call it 'invest' in your customers.

Revolutionary developments in the computer and communications fields have forced companies to increase speed and become relevant. Markets are becoming global and economic activity across nations is becoming increasingly integrated. Competition can come from the face of a computer screen with the competitor sitting in a different time zone. About the only thing in business that is a constant, is change. As the world transforms at an unprecedented pace so have to the components that propel its engines. Thus a credit policy that is written without an understanding of the market and ample room for change in it and the one that is not frequently revisited could become obsolete in matter of days. With the information-age revolution, knowledge-based activities are becoming increasingly important for existence. Hence, enhancing skill-sets and knowledge is an intangible component of a credit policy.

I am of the firm belief that 'what gets measured gets managed'. Therefore as a matter of policy one should manage by measuring results. Every time a deal goes bad, review the things that were done incorrectly in either setting up of the account, monitoring or collecting it. Measure Days Sales Outstanding (DSO), aging receivables, and bad debts as a percentage of sales. Keep a tab on your liquidity by reviewing liquidity ratios like the current or working capital ratio. Also keep a pulse on your inventory turnover. This will tell you if your efficiency is increasing, decreasing or the same over different time periods. Profits are a combined function of liquidity and efficiency. You can use the same logic when assessing your customer.

Using quality information can help scores in managing risk. Collecting relevant information requires a well thought-out Credit Application. It should seek permission from your customers to conduct credit investigation from credit bureaus, trade and bank references for the purpose of granting credit. A Credit Application is a document that not only collects information but is also an 'Application for a Loan ' that the applicant fills. Make sure that your Credit Application reflects the sentiments that you are serious about the amount that you will be extending in the form of cash or kind.

As a guideline you can write your policy in the following sections. The contents of each section can be written to best fit the nature of your franchise:

1. The set-up of credit function.
2. Objectives of the credit function
3. Terms and conditions of sale
4. Sales responsibilities with credit issues
5. Billing procedures
6. Obtaining Information on new customers
7. Procedures for opening new accounts
8. Process of assessing the information to arrive at line of credit and credit terms that will be offered
9. Monitoring your investment in your customers
10. Profiling your customers to do strengths, weakness, opportunity and threat analysis.
11. The feedback loop for reporting
12. Allocating resources and responsibilities
13. Defining past-due and bad debts
14. Targets, benchmarks and deadlines for the credit function
15. Procedure of collecting from delinquent customers.
16. Analyzing the changing needs of your markets/customers.

Entering the marketplace by investing in a franchise can be one of the best ways that an entrepreneur can launch a successful business. Franchising in Canada continues to grow at a significant rate. Franchise sales in Canada in 1987 were estimated at $61 billion; and now it is close to 90 billion. The retail trade alone represents almost two-thirds of that number. It is expected that sales will increase 10 to 15 percent annually over the next few years. The person who operates a franchise gets the better of both the worlds - the satisfaction of operating an independent business, combined with the leverage of working for a large organization.

Ultimately, Credit Management is an art and not a science. It is definitely an 'indefinite'. It gets its design from a variety of inputs like the creativity, experience philosophies and attitudes of the individuals administering it. Sometimes a decision based on your 'gut' feeling against all odds could prove to be the best one. But as a credit adage goes "get the calculations right in a calculated risk" and remember that 'A sale is not complete till the money is collected.' Good luck with your franchise.

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Source: The above article appeared in the "Canadian Business Franchise Directory 2000". The directory is a complete guide to franchising in Canada and is available at major book sellers. Email:cgb@island.net