Credit Management: Policy, Process and the Credit Cycle
Credit management is the discipline of granting credit on terms that maximise profitable sales while keeping receivable risk within appetite. A candidate must be able to describe the credit policy framework: who approves credit, the standards for granting it, the terms offered, and the collection and monitoring procedures. Understand the credit cycle from application through credit assessment, limit setting, documentation, disbursement, monitoring, and collection or write-off.
Key concepts include the five Cs of credit (character, capacity, capital, collateral, conditions), credit limits and exposure ceilings, credit terms (credit period, cash discount, settlement discount), and the cost-benefit trade-off of loosening or tightening policy. Know the components of a credit policy document and the difference between a credit policy and credit procedures. Understand concentration risk, related-party limits, and the role of a credit committee.
Common traps: confusing a cash discount with a trade discount; treating a credit limit as a guarantee of repayment; assuming tighter credit always increases profit (it may reduce sales); and mixing up the credit period with the discount period. Another trap is treating the five Cs as interchangeable with a credit scorecard.
Worked rule of thumb: to evaluate a proposed relaxation of credit terms, compare the incremental contribution from extra sales against the increased cost of carrying receivables and bad debts. If a firm sells on 30 days and considers 60 days, the extra financing cost is the increase in average receivables multiplied by the cost of capital, plus expected bad-debt losses. Only relax if incremental contribution exceeds these costs.