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Why implement a process of credit assessment?
In brief, the main objective is to predetermine a monetary level which can be described as a maximum, or in certain instances, as a monthly figure, to which credit will be permitted to a particular customer.
The principal danger with regard to setting monthly levels is that the maximum at any one time is then geared to the length of credit taken. In general therefore, monthly limitations of credit are only acceptable where the industry or trade concerned is in a position to stipulate categorically that payments will be made within 'X' number of days, normally 14 or 30.
The principal factors comprising skillful sanction of credit are:-
How, therefore, is an individual to appraise a risk by assessing in advance what is likely to be experienced relative to the above factors?
The main source from which an initial assessment can be made is of course financial reports and statements, primarily trading, profit & loss accounts, and balance sheets. Is the company trading profitably? Are the profits purported to be made realistic? Is there an ever strengthening position with regard to Net Worth? Is there a strengthening of assets paying particular attention to freeholds? Conversely, is there a depletion of assets? Is there an ever increasing reliance on loan capital ? and in the first place, is the company adequately capitalised by the shares issued and fully paid?
In the case of new customers, as opposed to those risks which are being reviewed, the most common and traditional method of establishing the customer's payment policy is a credit report and trade references.
In normal circumstances Credit Controllers would adopt this method of assessment, and consider this to be their prime and most significant source of information. It is necessary however, to stress the limitations of trade references, particularly as far as the dubious risk is concerned. Where the potential customer of doubtful credit standing wishes to develop a number of purchasing sources, then clearly it is only necessary for them to foster three trade accounts, ensuring that terms are strictly adhered to, and in so doing become possessed of three trade referees who would feel obliged to give an exemplary reference. In this way of course, the potential customer is endeavouring to project an image of an organisation which, as a matter of policy, pays to terms.
Notwithstanding the shortcomings of trade references, if intelligently used, they can be beneficial in the process of credit sanction. One such benefit is the trading style confirmation.
As a means of endeavouring to overcome the trade reference weakness, attempts should be made to develop the acquaintance of credit control contacts or line management contacts in other companies where off-the-record references will frequently be given.
Credit Circles are becoming ever more popular as a way of keeping up to date with customers paying habits.
When considering a trade reference, wherever possible a check should be made to confirm whether any director of the company provided as a referee is also a director of the subject under enquiry. In cases where this is established, then obviously the worth of the reference is nearly always diminished.
Generalisation within this factor can be misleading and dangerously inaccurate. From registered failures over the past ten years, it is a statistical fact that certain businesses present a greater risk and are more susceptible to failure.
Due consideration must be given to this factor in the light of the ability of a company to realise on part of its assets in the event of a liquidity crisis, and availability of bank credit.
It is the view of many organisations that a credit sanction policy should be flexible to the extent of remaining compatible with the economic conditions prevailing at any one time. The logic of adopting this view is understandable, but its merit is questionable.
Assuming that the credit appraiser pays full regard to all the aforementioned, the next basic ingredient is full knowledge of the potential customer's realistic requirements. All too frequently credit limits are sanctioned in an arbitrary manner and within a short period the level of trading results in the credit limit being exceeded. In such cases internal anxiety can develop, and more often should develop, which subsequently leads to credit restrictions and a breakdown in customer relations arising out of irritation caused by the credit department.
Effective credit sanction is therefore a joint effort where sales, management, and credit control must all make a significant contribution. Many individuals specialising in credit control consider that their view should be the first and the last word in any credit sanction decision. This philosophy, if accepted, must lead to unnecessarily restrictive credit sanction and the real possibility that the limits approved will be meaningless in relation to the amount of credit granted.
Obviously, from the point of view of sales, each sales person is quite rightly anxious to ensure that the orders which he obtains are accommodated within the levels of credit sanctioned. From this point of view it is suggested that due consideration be given to the credit function, and particularly in those cases where unusually attractive prices seem readily available. The significance of this warning is best explained by suggesting that a sales person selling a product in a highly competitive market, should always question the reason why an order comes his way with the prospect of an attractive price and profit margin, with little or no solicitation. Experience has taught that in many of these instances the customers concerned are purchasing out of desperation, with the majority of their supply sources terminated.