Effectiveness of the Credit Management
Improve risk management
Collaboration with sales
Article written by Jean-Marie Bequevort, Expert Practice Leader, CFO Services. Analysis by Jo Uyttersprot, Expert Manager, CFO Services Credit Management
Think about it: in many companies, accounts receivable is the largest asset on the balance sheet and the expectations for the function are clear: set up processes and controls to investigate the creditworthiness of customers, keep up with the status of receivables, and take the necessary steps to collect late payments.
The survey results offer a data-driven perspective on the state of the credit management function and the challenges faced by Belgian credit managers in meeting expectations.
In this first article, we share three observations related to the set-up of the credit function, the most popular metrics, and the main focus of credit and collection resources.
Even though the most effective way to collect payment is to have a team calling customers to remind them to pay their invoices, our survey reveals that 8 out of 10 companies with fewer than 100 FTEs do not have a credit and collection department.
Most SMEs of that size have attributed responsibility for the function to one dedicated employee, although there’s not always enough budget to do even that. In companies with fewer than 100 employees, the person in charge of credit and collections rarely has the function of credit manager, and, in most cases, works in the sales organization. In SMEs with 100 to 250 employees, credit management becomes the responsibility of the CFO and finance manager.
A more important driver for companies to set-up a credit department, however, is the number of active customers. Of the surveyed companies with fewer than 100 active customers, none had an organizational structure for the credit function in place, whereas 7 out of 10 companies featured a credit department once the customer portfolio breaks the threshold of 500 active customers.
Yet, the credit and collection department remains traditionally small in our country, with 6 out of 10 companies reporting a structure of up to 5 employees. Larger structures are to be found in organizations with a large and fragmented trading portfolio. There, 9 out of 10 companies with 500+ trading partners have a credit department that exceeds 5 credit professionals. Surprisingly, in terms of functional leadership, there is no statistical pattern emerging from the survey with 4 out of 10 respondents admitting unclear accountability or ownership residing outside finance.
The most widely adopted performance metrics are the simplest to monitor - the ageing balance and Days Sales Outstanding (DSO), both indicated by 7 out of 10 companies. The ageing balance summarizes all the accounts receivable split by age, it’s a fairly straightforward method to gain a snapshot on the amount outstanding and the ageing of the balance (versus due dates) by customer. DSO is commonly used to describe how quickly a company is getting the cash it is owed into the bank account. What’s striking is not the use of those metrics but the fact that one-quarter of the companies surveyed do not track any of those measures.
Yet, despite their wide adoption, it’s important to put these metrics in context, especially if you wish to measure the effectiveness of your credit and collection team.
First - if the company policy is to set terms at 30 days, it is likely that the DSO will never go below 30 days. In that case, the metric ‘best possible days sales outstanding’ is used, albeit by only one out of ten respondents.
Secondly, many factors beyond the influence of the finance team can impact the metrics: product quality issues, missing or incomplete documentation, etc.
According to Dieter Verbeek, ‘a combination of different indicators leads to effective credit management performance. A hard approach towards a loyal customer who has one invoice overdue for the first time is counter-productive. In the end, credit management is mostly relationship management’. Surprisingly, the percentage of bad debt is a metric only used by 3 out of 10 respondents, a result probably driven by the low proportion of uncollectible receivables reported by our panel.
While the proportion of receivables reported as uncollectible is lower than 2 percent on average, Belgian credit managers continue to face challenges in their collection activities, with 4 out of 10 companies operating with a percentage of overdue between 10-30 percent of the total receivables balance. Conditions that translate into a workload focusing primarily on three main activities: collection, provisions for doubtful debtors and the management of sales orders on credit hold.
‘A remarkable finding,’ says business manager Dieter Verbeek. ‘These key activities take place in the tail - being the latter stages - of the credit management process, whereas one would expect more focus on risk management and debtor assessment, which are all part of a proactive approach to control and improve the cash-flow cycle.'
Even with 7 out of 10 companies using a credit policy, the survey indicates an opportunity for credit managers to act earlier in the process and provide stronger financial and risk management insight into the sales process. An impressive 60 percent of companies indicate that the decision to onboard a new customer remains the sole responsibility of sales, with 50% of respondents admitting the absence of proper 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), the reputation of the customer (4 out of 10), or the industry of the new customer (2 out of 10).
Another likely factor is inadequate alignment with the Sales department, a situation flagged by 2 out of 10 credit managers. ‘All too often, credit management is seen as the bottleneck, the department refusing to extend credit to close a deal' says Dieter Verbeek. In such instances, sales managers will prefer to rely on their own judgment rather than spending hours debating with the finance department.
From experience, we know the problem usually starts with attitude. A good credit controller should look for ways of saying ‘yes’, enabling the sales by looking for adequate alternatives such as partial deliveries, special credit terms, instalments, discounts, and deposits. In addition, credit and the broader finance organization should look to invest in technologies that provide the sales team with real-time decision-making at the start of the quote-to-cash cycle. In Want Better Cash Flow? Listen to Your Credit Team, Eric Dowdell illustrates how certain companies integrate their credit management system with the Customer Relationship Management team (CRM) to provide real-time credit decisions to salespeople in the field. Sales cycles are thus shorter because more than 90% of credit decisions are handled by the automated process. Just a small percentage of the kick-outs require manual review, and the credit team is seen as an essential partner by salespeople.
This article is the first of a series that will explore current credit management practices, offering ideas to improve the 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.