Credit management is a mysterious subject, not a lot of people outside the field know exactly what it is! Credit exists soon after money was invented centuries ago and commercial credit is the backbone of all business trades. In fact, most businesses are financed by their receivables. Commercial firms would face dire consequences if they have problems in recovering their accounts receivables. Yet commercial credit management is not being taught at higher education levels. At university, there are all sorts of modules relating to the business world such as finance management, marketing management, distribution management etc. How often do you see commercial credit management being offered? If commercial credit management is that important, why does that happen?
Commercial credit management is an often-misunderstood subject. There seems to be no consensus on its scope or how it should operate. On recruitment advertisements, very often the principal requirement for credit managers is a qualification in accounting. I even saw one advertisement specifically asking for a chartered accountant to fill up their vacancy. Apart from the fact that credit management is, very often, under the scope of finance; I do not see the direct relevance.
Credit manager is like the goalkeeper in a football team, never the highest-paid player but often get blames for letting in goals
It is often suggested that credit managers are not being treated with the right respect they deserved. They are often seen as a hindrance towards achieving target sales and have the unwelcome and difficult task of protecting the company’s cash flow against possible bad debts. Yet credit managers often are not being put at the right level of authority to perform effectively. Is there something wrong with our business mentality?
A few months ago, a group of credit managers suggested in the HKCCMA web site that they are often being mistreated from work to compensation levels. They suggested that credit manager is like the goalkeeper in a football team, never the highest-paid player but often get blames for letting in goals. The goalkeeper analogy is interesting. Perhaps we should look at what makes a world-class goalkeeper.
Being a goalkeeper, no matter how good you are, you will not get very far if you keep allowing strikers to have a go at you inside the penalty area. Therefore a good goalkeeper must have the ability to organize the defense around him. Moreover, it is also the goalkeeper’s job to initiate quick counter-attacks to benefit offense. A world-class goalkeeper is therefore, someone who has good reflexes, ability to communicate effectively with teammates, capable of withstanding pressure and most importantly, ability to read the game.
It seems that that there are some similarities between a goalkeeper and a credit manager. A good credit manager should communicate effectively with the Finance and Sales departments to set up an effective credit policy as the backbone of the defense. Secondly, the credit manager should always be ready to take calculated risks to assist Sales. Lastly, the credit manager must also have the ability to “read the game”. That means the credit manager must have sound knowledge on the markets his company is in and the products that they are selling. I have seen some good managers who even have better product knowledge than their sales colleagues. The result? They tend to be anticipative of their market and have more understanding of their customers to facilitate a fine-tuning of their credit policy.
The goalkeeper analogy is a good indication of a good credit manager in an overall sense. What about the micro aspects? What kind of knowledge a credit manager must have in order to perform effectively? What kind of knowledge could put the credit manager in a position to organize the defense and ultimately reduce the company’s credit risks?
I have mentioned earlier that there is no direct relevance between a good credit manager and a qualified accountant. However, credit managers do need a sound knowledge in financial management and analysis. Credit managers must be able to maximize the cash flow out of their receivables. They should be knowledgeable to consider alternatives such as factoring or invoice discounting to improve cash flow. In terms of risk transfer, they could consider taking up credit insurance to make their receivables more predictable.
Financial analyses on buyers, however, are not as crucial. That is because commercial credit management tends to concentrate on short-term credits – typically up to 180 days. In light of this, it does not make too much sense to produce an in-depth analysis on every customer. Moreover, you do not often have the chance to analyze your customers’ financial statements. Even if you do, you still have to rely on your commercial knowledge to judge the viability of that business on a short-term basis.
It is a common phenomenon that credit managers do not get along well with the sales staff. Very often it happens because there is not enough communications between the two divisions. Just imagine how the sales manager would feel when a sure deal was hindered by the credit people’s refusal of an open credit term. In many cases, the refusal of a credit limit is a direct result of a lack of concrete financial information on the buyer. If a credit manager insists on a cash on delivery term for the sake of being safe, how many new extra businesses can the sales staff bring into the company? There has been an interesting suggestion that credit managers with sales experience would become better credit managers. That is because they would be more sympathetic and more accommodating to the needs of the sales people.
Whether credit managers need to have sales experience is subject to debates. However, if a credit manager only see the issues from his or her point of view then a war with the sales staff seems inevitable. The fundamental role of the credit manager is to protect the company’s investment on accounts receivables without hindering any sales opportunities. In light of this, the mentality of credit managers should be one of furnishing maximum support to sales. The credit manager should try to come up with solutions to facilitate a deal by giving alternatives terms of sales. In this sense, credit managers do seem to have the need to at least have a thorough orientation in their organization’s sales department.
It is often suggests that credit managers are manager of commercial risks. So why do the risks come from? The simple answer is, it is from everywhere! For example, if a customer in California suddenly asks to change to term of sale from 30-day open credit CNF to 30-day open credit DDP, what does that mean? Well, first of all you need to know the difference between Cost and Freight (CNF) and Delivered Duty Paid (DDP). Needless to say, not only there is a change in the risk structure of this sale, also the costs will obviously be higher due to the duties and the additional amount of paperwork involved. CNF and DDP are two of the International Commercial Terms (ICOTERMS) and there are many more! How about terms concerning letter of credits? How to make sure the bills are clean? What is a stand-by credit and how is it different from a bank guarantee? All these questions point to the fact that credit managers need to have a sound knowledge in commerce.
Commercial credit management involves the protection of receivables. In many occasions it is the duty of the credit manager to first examine the contract made between the company and buyer concerning credit issues. While it is shrewd to have the contract further examined by a lawyer, however, the credit manager should be in a position to give initial advise on the enforceability of the contract on credit issues. How should a contract be worded if a parental guarantee is involved? Is the guarantee involves third party rights? The credit manager should be able to pin point the possible cracks. To be able to do that, a workable knowledge in commercial laws seems necessary. Having that knowledge would enable the credit manager asking the right questions and seek advises from the appropriate sources. Let us not forget, an unenforceable debt is not a debt but a total loss!
Knowing your customers is an important aspect of credit management. It gives you an idea on the kind of risks you are involved. However, credit investigation is an often-neglected area of credit management. Many credit managers are not thoroughly trained in this respect. The reason is rather simple; there is a lack of facilities and expertise in a commercial firm to offer that sort of training. Many credit managers would rely on credit information agencies to provide them with information on their customers. By ordering a credit report, many credit managers felt that the investigation has been completed. Credit information reports are only as good as the ones who read it. If you do not understand how and where the information comes from, the chances are, the credit reports are not going to give you much help and value.
A good credit manager should be familiar with public sources of information such as the Company Registry, the Land Search, Business Registration search, Court Writs etc. Very often a tiny inconsistency from a public source of information could expose a potentially huge problem on a customer. So are you going to consider doing business with this customer or do you need to find out more?
I have mentioned financial, sales, commerce, legal and credit investigation skills as some of the key elements of commercial credit management. There are other important skills too. Credit managers should be proficient in debt collection to improve their day sales outstanding. When to start the debt collection process on customers is a subtle art and the most effective way to collect debts varies depending on the situation. Last but not least, the credit manager should have good operation skills to integrate all mentioned knowledge into a comprehensive credit policy so that the company can have a consistent tool to rely on.
To conclude, there are many ways on how to manage credit in a commercial firm and there are no straight formulae of success. A good credit manager should run a credit policy that is effective, efficient, consistent and inexpensive.
I have been told that, due to a lack of formal training on commercial credit management, many of the good credit managers are accidental heroes. They do not have an ambition to become credit managers when they start but made a success out of it through their personal qualities and experience. Some people even suggest there are less than a dozen of truly brilliant credit managers in Hong Kong! Personally, I think that is an unfair judgment of the credit management profession. In light of this, the credit management profession should be more formalized so that commercial organization could clearly see the importance of commercial credit management and organize this function accordingly.
Author: Mr. Stephen S. K. Lo is the Head of Credit, Asia Pacific of Bayer Polymers Ltd. and the Chairman of the Education Committee of the Hong Kong Credit and Collection Management Association.