5 Biggest Credit Mistakes Part 1

My name is Jay McKeown and I have been a designated member (CCP) of the Credit Institute of Canada since 1992.  I am the Past President and Dean of the CIC, and I have been working in Credit and Collections since 1988.

I believe that Credit and Collections people: lead, evaluate, research, analyze, monitor, decide, document, influence, persuade, negotiate, communicate, advise, teach, coach, and…help sales sell. 

The modern word “Credit” comes to us from a Latin word which means to trust, or to believe, in someone or something.  We have other words in the English language which are derived from this Latin word, such as credible (you can believe it) and incredible (no, you can’t believe it).  If you strip away financial statement analysis, credit reports, bank reports, payment trend information and default and delinquency indicators, Credit is essentially about trying to figure out who you can trust and who you can believe.  

The good news is that you can trust most people you do business with to do the right thing, which means they will pay for the stuff or the service they bought from you when they are supposed to (more or less).  The bad news is that there are a few people out there who are determined to do the wrong thing, and there are lot of good people out there who end up being unable to pay their debts for one reason or another.

In this series, I want to address the 5 main mistakes businesses make when managing their Credit and AR, and to offer some suggestions that may help along the way.  

The Mistakes are:

  1. Not having a Credit Policy
  2. Not knowing your customer
  3. Waiting too long to collect 
  4. Missing the warning signs of insolvency
  5. Leaving Credit decisions to non-Credit staff  

Part 1 – Not having a Credit Policy 

To get a credit card, a mortgage, or a car loan, what’s the first thing you have to do?  That’s right, you must apply.  You fill out a form.  And in applying you give a lender enough information to make an informed decision and, with any luck, approve your request.  Sometimes the Credit being offered is unsecured, like most credit cards, and sometimes there is security or collateral requirement, like your house which secures your mortgage or your car, which secures your car loan.   If you don’t make your payments as agreed, then you default on the Credit and chances are the lender will take the security that you pledged to them to pay the remaining balance that is owed on the debt.  These lenders know when and how to take these steps, because they have a policy which tells them what to do if a borrower does not pay.  This policy covers what they should do from application for Credit to collection of the debt.

If your business lets your customers receive goods or services now in return for a promise to pay later, then your business grants Credit.  And you are not alone.  Most businesses grant Credit of some kind to their customers, especially if their customers are other businesses (B2B).  In fact, this is the most common type of Credit offered in the business world and most of the Credit offered in this way is unsecured.  In my opinion, every business that grants Credit should a have a set of rules which tell staff what to do about Credit.  This set of rules is called a Credit policy and this policy should provide enough detail to let staff know what they can do on their own and what they can do if they get approval from someone more senior in the business.  

Do you treat a request for a $5,000 Credit limit the same way you treat a request for $10 Million?  I don’t think so.  Credit policy should spell out what information is needed (on an application) to approve an initial request in each case.  Should accounts be reviewed periodically?  The policy should spell out if a review is required, when a review is required, and how much information is needed.  Should customers have to provide financial statement information, along with their application?  The policy should tell staff when financial information is required. If you want to know what to do about accounts that are past due or over limit, the policy should make that clear.  What about payment terms and payment methods?  Staff should be able to refer to the policy to get the answer.  The policy should also cover subject such as write offs, bad debt provisioning and delegated authorities.

Ultimately, having a Credit policy only works if people know about it; what it covers and what the rules are.  Put another way, why have a policy if staff don’t know what is, or what it means – after all, is it a secret?  So, the next step after you get a Credit Policy is to tell staff about it.  Enter the Credit team.  They should meet with owners and/or senior managers, to get them to buy in and sign off, if that has not happened already.  Once this is done, the next step is to bring internal stakeholders up to speed.  The Credit team should ensure that everyone knows (especially in sales) what it takes to get a new account approved (application, credit history/reports, maybe financial information).  What does it take to release an order on credit block?  Do the staff in the warehouse know what to do, and who to contact to get approval to release a blocked order?  The Credit team will have to take the lead in communicating policy to other staff and stakeholders.  And the Credit team should be aware that this will not be a “one and done” kind of effort; it will be ongoing.

Communicating Credit Policy is part of a larger role that the Credit team has in every business.  I believe that Credit teams are most successful when they are involved with the business.  What I mean is that I see Credit as a part of the business, not separate from it. To be successful, Credit should meet regularly with sales to go over results, resolve issues and problems, talk about opportunities, and future plans.  Credit should ask for time on the sales meeting agenda to provide updates on things like AR performance, to report what is going on with DSO, past due %, and bad debt provisions.  Be transparent and explain what Credit is doing and why it is doing it. What if the customer has a problem?  Let everyone know that the customer can talk to Credit, anytime.  Offer to pre-qualify leads and to help vet sales contracts before they are signed.  

The more that Credit is involved with the business, I believe, the more successful the business will be.  To achieve this goal of being involved in the business, Credit should communicate to stakeholders, as much as possible.

After reading all of this you may be saying to yourself, great, but how do we do this and what should our policy look like?  Start by asking the staff on your Credit team what they think and go from there.  

And if you are really stuck for answers, reach out to the Credit Institute of Canada; we can recommend some experienced Credit Managers to help you out. 

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