‘Banklike’ credit control

Every banker manages the loan portfolio actively. A credit department of a company with outstanding receivables is no exception. Both extend credit to customers, implement policies and procedures and ensure that the extension of credit supports the organization’s growth strategy.
A credit policy specifies the lending practices that will be employed when extending credit to customers. However, credit policy objectives cannot be met without good credit quality, which is enhanced by a deep knowledge of customers and their businesses, as well as a sound calculation of risk. A credit policy provides rules for various credit metrics by using industry benchmarks, like the bad debt expense ratio, the allowance for doubtful accounts, etc.
The allowance of doubtful receivables is an estimate of receivables that could go uncollected, which is similar to the loan loss reserve ratio for a bank. For businesses, the average allowance is generally 1% (or less) depending on the industry.
Bad debts are expensive for companies and for banks. For example, a company operating on a 10% gross margin must generate an additional 250,000 in new revenue to cover a 25,000 in bad customer debt. Similarly, a bank must generate 25 million in new loans to cover a 500,000 in bad debt, assuming a 2% net interest margin.
Credit departments should establish credit limits for every active customer, based on credit reports and financial statements analysis. In cases where a customer’s credit quality is not strong, alternative terms of trade should be considered in which credit can be enhanced (credit insurance, letters of guarantee/LCs, selling receivables on a non-recourse basis to banks through factoring, etc.).
Collection practices are also important.  A thorough policy outlines the time frame in which a customer becomes a collection hassle, describes the collection process, specifies the parties responsible for collecting, outlines the timing of a deemed charge against the allowance for doubtful accounts, etc. Uncollectible accounts are often referred to collection agencies or attorneys.
In all cases, closely monitor the payment history trends with customers and do not ignore industry data and local/global economic conditions. Regular review of credit policies is required to ensure that sales and credit are working well together.
 
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