By George Portanier
Offering credit is, of course, when a company sells its goods or services to a customer and agrees to be paid later. The provision of credit helps to drive business and to oil the wheels of economic growth. The reasons for offering credit can vary according to the industry, the type of product, the level of competition in the market, the demands of the customers and the objectives of the firm offering credit.
In a business-to-business transaction, an upstream firm would extend credit to give its business customers the time they need to add value to their products and then promote and sell the goods to the next customer in the supply chain. In business-to-consumer transactions, firms extend credit to individuals who may not have sufficient liquid funds to pay for their purchases immediately, but who are able and willing to pay in instalments according to the agreed terms.
Lending can therefore be seen as a form of investment in the customer, and like any other investment, it carries risks and costs money. This implies that companies that grant credit should protect their investment by minimising the risks and costs involved. As such, the credit function is one of the most sensitive departments within a business, as it is responsible for ensuring that customers honor their payment agreements, thereby protecting the company’s cash flow, which is the lifeblood of any business.
Credit managers are not just responsible for crunching numbers and mitigating risk. They are of great value to their respective organisations because they are the ones who deal directly with customers throughout the transaction. In this way, the credit function can be seen as an extension of the sales function, helping to raise the profile of the company and build a long-term relationship with the customer. This, in turn, would help to gain and maintain a competitive advantage in the marketplace and increase the likelihood of repeat sales, thereby enhancing the synergy between the sales and credit teams.
The credit function should never be seen as the ugly stepchild of the finance department, a necessary evil. Credit professionals should be skilled, well trained, and ideally involved in the business strategies and decisions of the company. They can add value to the business by being able to distinguish between ‘sales’ and ‘profitable sales’, so that a company with significant revenues does not lose out on healthy cash flow and long-term profits through late payment and the generation of bad debt.
The credit function is a people function and one of the roles of the credit team should be to gain and maintain competitive advantage in the marketplace by building and maintaining long-term customer relationships. Going back to the basics, if a company were to examine the reasons for granting and extending credit to customers, it would soon realise that there may be different answers for different companies. After all, the cost of granting credit is offset by the profitable sales that would otherwise be lost.
In the B2B sector, the question is whether suppliers can make a profit on credit sales if their customers’ businesses are not sustainable. The maxim ‘know your customer’ immediately comes to mind. Building and maintaining long-term customer relationships is the best recipe for getting to know your credit customers better. Suppliers should therefore be proactive when granting and renewing credit to customers. They need to make sure that their customers’ businesses are doing well or have the potential to do well in the future. Suppliers need to ensure that the customers requesting credit are not overtrading or mismanaging their business and that they have the skills to run a profitable business.
Suppliers should not be afraid to refuse credit if they believe that granting it will result in unpaid invoices and bad debts. However, suppliers should also feel a responsibility to help their customers who ask for credit. The credit manager should explain why credit is being refused. Otherwise, if a supplier granted or extended credit to a customer whose business model did not appear sustainable, both parties would suffer. The customer’s financial position would deteriorate, its ability to meet its obligations would be reduced and, ultimately, the supplier would not be paid. This scenario would only lead to litigation and more cost and pain for both parties. This is why it is so important to carry out a credit assessment before granting credit and to monitor existing credit accounts on an ongoing basis. A lack of proper credit management by a supplier would only jeopardise its cash flow and profit element.