What do you mean by Credit Risk Management?

A company expects to be paid. It is payment that creates profit – not the sale. The underlying philosophy behind smart credit management is, a sale is only a gift until it is paid for!

The risk management of a company has an impact on its balance sheet, and how suppliers, customers and investors perceive it. Credit management forms part of the overall risk management, taking decisions on how much credit is given to each cus­tomer, how the payment risk is managed, and on policy and strategy, including action needed when payment is overdue, or there is a perceived risk of default.

The credit management need not be seen as putting a brake on the activities of the sales force: if consultation is early enough, prudent credit management will be able to design appropriate yet competitive terms of payment. The credit decision will be guided by company’s overall risk strategy, the cost of financing the sale, and the creditworthiness of the customer.

While the long term objective is to ensure that a company takes reasonable risks, and buys risk protection (e.g. credit insurance, without recourse factoring, or letter of credit confirmation), there may be specific occasions when, for sales purposes, or to keep a factory running, high risk transactions have to be undertaken.

Insurers and lenders will be keen to see that the company is well managed. The quality of a company’s credit risk management is immediately visible in the financials through the aged debtor analysis and the receivables shown on the balance sheet.

The company should ideally have a written credit management policy that sets out the management procedures for minimum risk. This is especially important where the company has more than one business site.

By adhering to a uniform set of procedures, the credit managers ensure that minimum standards are being used for the protection and management of the company’s assets, and this provides a level of comfort to the company and to the lenders.