Review your customers' risk profile
Set a maximum credit limit for each customer
The sheer existence of a credit policy increases the level of controls in your company
In a first installment, Mapping the Credit Function in Belgian Organizations, Jean-Marie Bequevort discussed the organization of the credit function and some key metrics. In this second article, he examines the benefits of a credit policy and the processes and controls adopted by Belgian credit managers to check creditworthiness, set credit limits, and establish payment terms.
To attract new business, reward loyal customers, and gain flexibility, up to 32 percent of Belgian B2B sales are made on credit. Given the growing use of credit as a tool for growth, setting up an effective credit control system is vital when it comes to optimizing cash flow and avoiding bad debts.
In an ideal world, a credit manager would review the creditworthiness of each potential customer before offering credit. But that’s not standard practice in Belgian companies today. According to our survey results, an impressive 50 percent of credit managers admit the absence of proper and systematic credit reviews for new customers.
The most frequent reasons to justify such a high commercial risk tolerance are the size of the contract (5 out of 10 respondents) and the reputation of the customer (4 out of 10).
For companies that systematically review a new customer’s risk profile, a large portfolio of tools is available: bank reference, information from credit rating agencies, financial statements, information from financial media and even a visit. Our survey reveals that managers use multiple inputs such as data provided by external financial information providers (6 out of 10 respondents) and the conduct of financial statement analysis (4 out of 10 respondents).
Risk screening channels
After assessing the credit risk of a given customer, a company must decide on whether to provide credit or not. How much credit is given will depend on how much business you expect to make with the customer, but also on the payment terms, and more importantly, on how much your company can risk losing. Our recommendation is to set a maximum credit limit for each customer and give new customers a modest limit to begin with. The limit can be raised from the moment it is justified by the strength of the business relationship. Surprisingly, 4 out of 10 companies indicated they did not use credit limits.
The use of credit limits
In addition, our view is that credit limits should be reviewed regularly to account for changes in the financial and legal situation of the customer, also reflecting the quality of their payment behavior.
Let’s not forget, giving credit remains a business enabler, and business might be lost if customers are offered more credit by competitors. Here again, the survey shows a wide spectrum of results in the frequency of credit limit reviews, with up to 40 percent of respondents admitting to never review the limit.
“A yearly review of the credit limits is essential in order to build a long term relationship with your client and securing the continuity of your company,” says CFO Services’ Virginie Buydts, who is an expert manager in the Credit Management practice. “Continuously monitoring your client information will systematically generate data that will enable the credit department to become more data-driven and KPI-based.”
For the companies establishing a credit limit, however, the survey shows homogeneity in the allocation of authority to C-level executives and the credit department. When it comes to setting up payment terms, nearly 7 out of 10 respondents grant their customers 30 days or less to settle their invoices. A result that is perfectly in line with the latest Belgian barometer published by Atradius with B2B customers receiving, on average, 27 days to fulfill their payment obligations.
Standard payment terms
A credit policy is a governance tool, a high-level statement of management intent, clarifying expectations and direction. The CFO Services survey provides a good picture of a credit policy’s building blocks. It also demonstrates how the sheer existence of a credit policy increases the level of controls in a company. In Belgian organizations, 7 out of 10 respondents reported the existence of a credit policy that often covers a broad range of parameters, from customer segmentation, credit decision and dunning to bad debt management.
Processes in the credit policy
When a credit policy is in place, the survey reveals the existence of stronger controls and a more influential role for credit managers in assessing customers and securing receivables. No less than 8 companies out of 10 that do not have a credit policy never review credit limits, down to 4 out of 10 for companies that do have a policy.
For Filip Ceulemans, client partner at CFO Services, the survey shows that the existence of a credit policy is a prerequisite to improve financial controls over trade receivables. 'The biggest benefits of a credit policy,' he says, 'are that it establishes a clear standard for your customers and improves cross-functional cooperation, especially between the credit and sales departments.'
This article is the second of a series that will explore current credit management practices, offering ideas to improve financial management and controls over the sales process. The series is based on an online survey that drew responses from more than 60 Belgian companies of all sizes, with questions extending over governance, organization, performance measurement, operational practices, and technology adoption. The Survey ran from September to December 2018.