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Lessons about Business credit management

Credit management, in short, is a process of collecting money for goods or services provided to another person. Learn from my mistakes and do better ☺️

By Edison AdePublished 2 years ago 11 min read

One of the first creditors to whom a business owes money is itself. How you finance your business affects how much it costs to run and whether you make profits. Paying yourself and paying suppliers not only costs money, it affects cash flow and income as well.

Credit management, in short, is a process of collecting money for goods or services provided to another person.

A business can't run without collecting money from some of its customers and using it to pay others. And running a small business is similar. You never know how much income you will get. In case you encounter a huge debt, it is easy to fail if you don't manage credit wisely.

Credit management is one of the essential terms of business. It involves developing a strategy to manage credit with your clients, suppliers, and others you do business with. When properly applied, good credit management can save you money, maximize cash flow and provide security for the future of your company.

Credit management is a practice that helps businesses protect their cash flow and profitability. Simply put, it's the practice of making sure your receivables get paid on time.

One of the biggest problems with credit is you don't know who to trust. And it's tempting to think that, if you had enough information, you could figure out who to trust and then take on a bunch of risks. But that isn't how it works. Banks have lots of experience figuring out which customers are good risks, and they still make lending mistakes.

I have been in business for more than 12 years, I have learnt a lot about credit management.

Credit management is my biggest lesson for the past 24 months. I personally lost $6, 000 to a client in Malta because of a lack of good business credit management on my part. I don't want you to make the same mistake. So this article is for you ☺️

Here are some tips for savvy credit management:

Every credit policy tells you what your company will do if a customer doesn't make a payment on time. It also tells you what process you have for doing that. You have to have a credit policy because it affects your cash flow and the risk of loss if customers do not pay. If a customer doesn't pay -- either on time or at all -- then you have to take action to protect yourself against further losses.

Establish credit limits for your customers

It is important to establish credit limits for your customers. This will help you to protect your business from possible financial losses. No one wants to see customers with no means to repay the debts, or just buy on credit without being in the financial situation to cover it.

Having credit limits in place will fundamentally help your business in two ways.

  1. It establishes clear rules for you and for your customer
  2. Credit limits work as a protection for you and your business.

While it is important to know how much credit you can extend, it is even more important to know how much you are willing to extend. It is very helpful to have a standard answer prepared for those customers looking for larger amounts of credit than you are willing to give. As soon as you have decided on your business budget and its parameters, be consistent in following it.

Credit limits should be set out of two main factors: creditworthiness and sales volume, both in respect to the individual customer and to the business as a whole.

Check the credit rating of your customers

Please check the credit rating of your customers before you extend them credit. If you don't, you'll be in for some nasty surprises. Your customers will be in the habit of not paying their bills on time and if you don't find this out on time you're going to have wasted a lot of money.

It is also important to check the credit rating of your customers before doing business with them. This will help you to identify any potential risks associated with doing business with them.

Not all companies do this. There are some companies that are ill-equipped to deal with credit checking and those kinds of problems. They tend to avoid the problem by having strict terms of payment and high-interest rates. It's not an uncommon mistake for companies to hope for the best or put a blind eye on the credit history of customers, hoping that these people would be able to pay the debt when payday rolls around.

Ensuring your business has clients with good credit ratings is one way to increase the chances of making more sales and generating more revenue. In a small business, the owner is usually the salesperson, cashier, and bookkeeper. There are things you can look for when checking records or asking questions to get a credit report on your customer that won't show up in a credit rating. Never extend credit to customers who have a low credit rating. While it is possible for a low rating to be the result of factors outside the customer's control, like personal misfortune or bad luck, there is also the possibility that such a customer might just be someone who regularly incurs debts and never pays them back.

Have someone dedicated to tracking debtors to your business.

The person's job is to make sure invoices are sent on time and follow through on aligning your credit management strategy with every customer interaction. You need someone responsible for making sure the money is paid to your business. If you are having a hard time collecting payments from your customers, you need to keep an eye on your money. You should have someone in charge of that part of the business, who can hold you accountable on a day-to-day basis while improving your credit management strategy. They need to be involved in any discussion about credit you have with your customers, regardless of how the business is run. They need to be involved in customer success as well, making sure that every interaction with a customer is monitored for credit management and follow-through. While you focus on growing your business and generating more leads and sales, your debt collector will be working hard to enhance your cash flow. These experienced professionals will scan the debtor's accounts to make sure the payments reach your bank account on time, every time. When they don't, these experts will follow up with your debtor and work with them to get the money owed to you faster.

Credit management is more than just sending invoices and following up with your customers. It's an essential part of good business practice and a key to your company's long-term success.

Credit terms should be set by the supplier in agreement with the customer.

Credit terms should be set by the supplier in agreement with the customer, because there are many limitations involved when a buying organization decides to set their own credit policies.

Businesses set credit guidelines for many reasons and these reasons can vary from one buyer to the other. The most obvious reason is that they want financial protection in the event that they get their money back late or not at all. A supplier must provide credit terms that are consistent with the effect of those terms on total profitability. There is no one right set of terms. He would be silly to set terms that result in a large number of unpaid bills and charge-offs, or to set terms that work against his overall financial policies.

A credit application form/agreement

This is a credit sales agreement and should include the terms and conditions of credit sales between a creditor and a customer. This document, once signed by both parties, sets out the agreed credit terms in accordance with the law and may also be referred to as a 'credit sales agreement.'

In case the customer wishes to apply for credit, that form needs to be filled and signed by the two parties. If a credit is issued, it should be adhered to, because said credit is to be used exclusively for purchases from the company. When there are changes in the customer's ability to pay (for example, when they have problems with their cash flow), the company should worry about it before giving them further credit and not after.

A credit application should not be taken lightly by any business. Taking a customer's signature on this type of form legally binds the business to the terms of the credit approach, including late payment fees, interest rate and any other terms agreed upon in the sales agreement. For a customer, signing such a document gives him or her security that the business is binding itself to a set of standards and understands precisely what is expected to be paid for any goods sold or services rendered on credit.

Late Payments.

Late payments are known to be among the top reasons for bankruptcy and organizational failures. As a rule, establishing credit terms with new clients is difficult. This can significantly push back the day when you can expect your first delivery payment from clients. Although it might take you several months to establish good credit conditions, such efforts will play an important role in building your business in the long run.

To reduce the possibility of losses from late payments and bankruptcies, suppliers should avoid exceeding credit terms and limits set with customers.

Getting paid within 30 days of invoice date is the goal as defined in most small business cash flow management systems. Late payments can have a series of negative effects. For example, late payments may increase the risk of bankruptcy or insolvency, which normally lead to a loss of a contract and an interruption in cash flows to the business. Furthermore, late payments will lead to a reduction in working capital which is essential for any business to continue operating smoothly. To prevent these losses from occurring, small businesses should set payment terms with their customers by considering both the industry and the size of the specific customer. By setting up credit limits and payment terms that include timely payments, small businesses are able to reduce their workload and also manage their accounts receivable efficiently. By default, business-to-business (b2b) and business-to-consumer (b2c) suppliers should take a proactive approach in billing and receiving payments. Unless agreed upon in the contract, failure by their customers to honour the payment terms should be treated as a breach of contract.

A breach of terms by a customer isn't just a loss of money to the supplier. It's a signal that the relationship between supplier and customer may be heading towards problems. A breach is like an alarm bell signalling the need to take proactive action immediately in order to reduce future loss. Following the logic and reason of customer payment behaviour is critical to achieving financial results.

This is a difficult issue as it's so important to keep the right balance between being perceived as a serious business and still retaining good relationships with customers. If you have really tried communicating with the customer and based on data available to you you foresee problems with the customer paying in the future, then stopping supplies is something that you should consider in a thoughtful and careful way. Communication with the customer is a two-way street. It is not enough to provide customers with information and then just wait for payment. The idea that you can continue to make deliveries without talking to your customers is ludicrous.

Factors that affect business credit terms:

  • The type of customer,
  • The size and financial strength of the buyer,
  • The supplier's operating cycle,
  • Seasonality,
  • Payment history,
  • Supplier's profit margin

A rough example of a credit policy

"We have simplified the credit policy at our business and it's based on three simple rules.

- The first one is that we do not issue credit at all to people who are seeking to finance consumption, those people whose only explanation for looking for capital is because they need money to purchase something they want. We consider a strong argument as to why they can't afford to wait until they can put more money down.

- The second rule is that we never offer any form of credit to someone we haven't met face-to-face. A personal meeting helps us get answers about their background, which gives us a better idea about whether or not we want to trust them.

- The third rule is that we never lend money to people with a bad credit rating. If you've been turned down by other creditors you're unlikely to be able to fulfil your obligations in the future, even if you're able to do so this time around. What's more, even if everything goes according to plan and you make all your payments on time it could take years for your credit rating to recover from the initial damage, particularly if you haven't shown responsibility with previous loans or charge accounts before."

I believe that one of the critical elements for success is the ability to manage credit risks. Stop offering that product or service to a non-paying client that has no clearly communicated way to pay what they owe. Don't overthink it. It will mostly end in tears if you keep procrastinating and afraid to make the hard decisions. It is a lesson I learned the hard way.

personal finance

About the Creator

Edison Ade

Business Strategist, Building Products for companies using Web and Mobile technologies. Fractional CMO.

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