Credit Extention

Conducting a credit investigation is one of the most important tasks performed by the credit department, yet the factors that shape the extension of credit can vary widely from company to company. Ultimately, the goal of a credit investigation is to assess the credit risk associated with selling to a customer in order to optimize sales and profits for the credit manager's employer.

Credit decision-making is a dynamic process. As internal concerns and external forces change, a credit manager must respond by either tightening or loosening the controls on extending credit. The ability to assess customer risk is the skill that enables credit managers to respond to these dynamics effectively and quickly.

Most business-to-business sales transactions occur on a credit basis. Screening new accounts and monitoring existing customers require experience, expertise and careful judgment. In order to effectively update active accounts and process applications for credit, the credit manager:

• Establish internal controls
• Limit the extent of the credit investigation
• Identify essential sources of credit information.

Establishing Internal Controls

The relationship between the credit and the sales department is the foundation for the credit controls that govern a company's new accounts. When an application arrives in the credit department, it should be logged. The person responsible for the credit decision should be identified, and if there is an order pending the application should be given top priority.

A credit application is a tool that helps the credit department efficiently evaluate a potential new customer. The sample credit application from the National Association of Credit Management contains the information necessary to initiate a routine credit investigation. Credit managers should customize their credit application form to include any other information essential to processing the application from their company's point of view. For example, some credit applications include a personal guarantee. Other applications include space for the applicant's financial data, and sales tax exemption information, as well as opportunities for comments from the applicant or the salesperson.

The legal name on the credit application is critical and must be verified. Where there is uncertainty, the credit manager should contact the Secretary of State's Office to verify the name of a corporation.

Once the name on the credit application is verified, the credit manager should consider how extensive the credit investigation must be.

Limiting the Extent of the Investigation

A credit manager can spend considerable time and money conducting a credit investigation. The credit manager's time and the direct expenses associated with the investigation -- credit reports, phone calls, postage, and customer visits -- all contribute to credit investigation costs. A credit department should develop specific policies and procedures that try to balance the costs and benefits of credit analysis. The following considerations can govern the extent of the credit investigation:

• If the profit potential on the product is high, it can justify a more thorough credit investigation.
• Where there is the potential for a long-term supplier relationship, a more thorough investigation may be justified.
• A large dollar order or large credit limit requested can justify an in-depth credit investigation.
• For small orders, some companies have a blanket policy to control costs. An example of a blanket policy would be to approve all orders under $50 without conducting a credit investigation.
• The credit risk that attaches to the customer can determine the extent of a credit investigation. For example, household name companies such as Intel ®, or AT&T® or Dow Chemical Company® might be approved quickly, but an application from an obscure company may require careful analysis.
• The nature of the sale can influence a credit investigation. For example, an export sale may require the need to set up a letter of credit. Likewise, a long-term secured credit sale could require extensive analysis of collateral and the need to perfect a lien.
  

Edited by Michael Dennis, author of "Credit and Collection Handbook" available at the NACM Bookstore.