B2B credit management is an integral part of accounts receivable management. Good credit management allows for consistent cash flow, smooth payment collections, and terms customers are happy with. But that isn't all. There's far more to B2B credit management, and getting it right can make or break your company.
Establishing A Credit Policy
Creating a credit policy is the first step in laying down a solid foundation. A documented and up-to-date policy allows new and existing employees to learn and understand the credit process. Having a hierarchy within credit management is also important. It ultimately drives the resolution of difficult or blocked issues.
The credit policy outlines the process of how to:
- Define credit limits.
- Define credit terms.
- Record transactions and keep a history.
- Take actions for nonpayment.
As new events occur and solutions are provided, the credit policy document should be updated.
How much credit a customer receives depends on how creditworthy they are. New customers present a higher risk than existing customers. You have hands-on knowledge about the creditworthiness of an existing customer because you know their credit history. For new customers, who you've never engaged with, creditworthiness must be determined remotely.
Using Dun & Bradstreet and Experian business reports is one method for determining a business' payment history. However, not all businesses have credit reports with these companies. Another way is to call their references/creditors. You can also view the company's financial statements, assuming they will allow it.
While we might think of an existing customer as low risk, it's easy to become complacent and miss warning signs. All customers should go through a periodic credit review and have their credit terms adjusted as needed to reduce company risk.
The above is part of the credit approval process. Whether its new credit or adjustments to existing credit, there's an approval process taking place. This entire process should be documented and kept up-to-date.
As a decision is reached on new credit or adjustment of existing credit, the reasons should be documented and accessible to the customer. Simply telling a customer their credit has been reduced isn't transparent and probably doesn't help in building long-term customer relationships.
Extending and Adjusting Credit
Extending credit can mean new credit for a new customer or more credit for an existing customer. Adjusting credit often means a restriction in credit for an existing customer. This can happen if the customer's business is in decline or the customer is having a difficult time in meeting payments. Reducing credit in this scenario is a way of reducing risk. If the situation continues to degrade, there may come a point where the customer no longer has credit with the company, and their payments have moved into collections.
What Are The Trends Telling You?
Is average DSO starting to increase or is cash flow decreasing? Don't let subtle trends turn into a crisis. As existing long-time customers continue to pay on time, you might feel the need to keep rewarding them with more favorable terms - 60 days, 75 days, 90 days, 120 days, where does it stop? If terms keep increasing but your supplier terms remain the same, eventually you'll have a cash flow crunch.
A cash flow crunch happens when cash flow isn't coming in quick enough to pay suppliers. Average DSO needs to be balanced against supplier terms so cash flow remains steady.
Another important area to monitor is bad debts expense. If bad debts are increasing, the company should investigate why that's happening. Finding the source of bad debts may unfold problems in the credit approval process.
Providing early payment incentives is common practice in B2B credit management. For example, you might offer a 1% discount for paying 10 days early and a 2% discount for 15 days early. How much discount to provide needs to be weighed against product cost, profit margin, and the current financial state of the company.
Are You In The Collections Business?
At what point should an invoice be written off? This is another way of asking, how long should you continue pursuing a late payment? If the credit policy imposes a fine after 30 days late, 60 days, then finally 90 days, should the invoice be written off at 120 days? Or should it be handed off to a collections agency?
If you don't have the resources to chase late payments, using a collections agency can be a viable alternative.
Depending on the accounting software being used, you may be able to easily provide an online customer portal. The portal will allow customers to securely log in and view invoices, statements, available credit, request a credit increase and make payments. Portals can be a great customer value add.
B2B credit management is an involved and important process. There are many moving parts. Taking the time to plan out your process while considering what's right for your company and customers will help in creating a successful credit management policy.
- Good credit management helps cash flow, smooth payment collections, and keeps customers happy.
- The first step in defining your credit management is to lay down a solid foundation and create a documented policy.
- When looking at your customer base, you should determine their creditworthiness, how to extend and adjust credit and what your customer portal looks like.
- When analyzing your credit management you need to determine what the trends are telling you in the market, if you are in the collections business or not, and what you determine are favorable terms.