Credit History and Strategy

The word Business first appeared around the 14th century and was originally defined to mean “purposeful activity.” Today, the inclusive term business designates the activities of those engaged in the purchase or sale of commodities or in related financial transactions. In other words, a business organization is a combination of functions, people and materials aimed at producing goods or services, and selling them to customers at a profit. The sale of most commodities is accomplished through the extension of credit.

Because business to business transactions normally involve the sale of goods or services on open account at a profit, the credit department plays an important, pivotal role within the business organization. At the same time, the role of credit and the credit department operations within the business organization have become blurred. The global business environment, coupled with leaps in technology, have changed not only the way in which and where business is conducted but who is conducting the business. The credit department is the link between customers and many other business functions such as marketing, sales, production, shipping, customer service and accounts payable.

Traditionally, the credit function was linked only to accounts receivable management. On a balance sheet, accounts receivable are reported as an asset instead of requiring cash at the time services are provided or goods are sold, payment is accepted at a later date. Accounts receivable was the responsibility assigned to the credit department. In the management of that responsibility, the function of a credit department was to evaluate the customer’s ability to pay and to manage the activities of collecting the payment. Traditionally, credit was about collecting money.  Today, that role has changed. The credit department is involved in the business process; i.e., the chain of events leading to the sale of goods or services at a profit. The credit department is involved from the time the order is solicited to the time the cash is collected. This order-to-cash responsibility reaches well beyond the financial evaluation of a customer’s ability to pay and collecting that payment. The credit department represents a business decision which requires both financial and strategic decision making to assure that a proper balance of benefit is derived from sales against carrying the cost or potential loss.

Strategic decision making is part of strategic planning, which is the key ingredient that underlies credit policy and procedures. Strategy can be defined as the art of devising or using plans to achieve a goal. Strategic planning entails the coordination of long-range plans with a particular focus on strategies, controls and desired results.

External factors such as social, political and economic, legal and technological and competitive pressures impact a company’s strategic plan. These external factors must be weighed in light of internal business factors such as production capacity, financial strength, human resources and marketing. Both these external and internal factors are assessed in terms of risk and reward. The role of strategic planning underlies the framework from which any policy, including credit policy, is formulated. Clearly defined goals impact upon accounts receivable to shape the resulting credit policy.

The Strategic Role of Credit

The credit department is involved with the customer cycle from the order to the collection of cash. The cycle involves the important task of information collection, credit analysis, collections and cash application, and deduction resolution. All of these elements have both financial and strategic implications in the business process.

Consider the following broad credit related areas. Each has both financial and strategic implications.

Collection of Information

The collection of information enhances the quality of financial analysis. That same information also has strategic implications; it can strengthen a company’s understanding of its customer base and lead to expanding that base. The credit department is, in effect, an information warehouse within any company. The information collected by a credit department can be used by a purchasing department to screen vendors or by the marketing department to help find new customers.

Credit Analysis

Credit analysis provides financial protection—whether the customer has the ability to pay—to a business and, depending on a company’s strategic goals, becomes an important factor in the sales decision.

Collection

While the credit department is responsible for the enforcement of payment terms, credit terms are a part of a company’s strategic business plan. Whether credit terms are restrictive or liberal will have a direct impact on a company’s strategic business plan as well as on the credit process. Cash forecasting is a natural transition for the credit department.

Cash Application

The financial impact of cash application is related to the timing of cash flow and the cost of carrying a receivable. The strategic implication of cost of carrying receivables is related to a company’s financial strength and its need for cash flow.

Deduction Resolution

The financial implication of the cost of carrying unresolved deductions or customer disputes impacts a company’s operating costs. Deduction resolution has very critical strategic implications because it is directly related to customer satisfaction, which in turn, impacts sales.

Edited by Michael C. Dennis, author of "1001 Collection Tools and Tips."