This is the fourth installment in our series, “Establishing Best Practices for Extending Credit in Today’s Economy.”
In our previous blog post, we discussed strategies to consider in developing your customer credit program. One of these is deciding which procedures or types of transactions to include in the program and what types of customers will be eligible for credit.
In this blog post, we will focus on the second part: deciding which types of customers will be eligible for credit.
Strategies for Assessing Credit Risk
When it comes to deciding who is eligible for extended payment terms and who is not, the decision should be based on a defined business strategy for offering credit and then on criteria that is consistently applied to all applicants.
First, let’s discuss strategies for offering credit. A properly designed credit program serves a business purpose. This may be to stimulate sales, provide a financing option to customers, or supplement an outside financing program. Within the context of the business purpose, a decision should be made regarding how much credit risk is acceptable.
For example, if the business purpose is to stimulate sales of a service, but stringent criteria are set for credit approval, the business may find a higher than desired percentage of applicants is declined. On the other hand, setting more lenient credit criteria may result in higher missed payments and bad debt situations. That said, it may be acceptable if the service is highly leveraged in terms of cost of sale, and the increased business volume generates additional profits that justify the bad debt dollar risk.
Credit risk should be assessed based on the business purpose and should be well understood prior to commencing the program. The business should develop financial models around the program to establish performance benchmarks that are monitored. Adjustments should be made along the way if performance is deviating from the benchmarks so that the business purpose is achieved as originally envisioned.
The second aspect of assessing credit risk is the consistent application of credit criterion to all applicants. This seems like a simple concept, but unfortunately, one that is often not followed. This can be avoided, by establishing clear, written credit criterion and a monitoring process to enforce policy compliance and external lending rules.
Effective Automation is Key
Automating the credit application, approval/denial process, and credit agreement stages of the payment plan process ensures consistency and can enforce best practices. Automation can go as far as to define the business rules for the credit granting process so that the approval/denial tasks are executed consistently irrespective of the individual processing the application.
One of the key aspects of the credit review and approval process is running credit and identity verifications on each applicant to obtain information regarding their credit worthiness while verifying his/her identity. An integrated, real-time service should be a required feature of any automated lending system.
Effective automation not only eliminates error-prone manual processes it can enforce lending best practices and significantly reduce the workload for existing staff. A robust, easy-to-use system provides a rich set of capabilities to maximize results even for a small business with limited staff.
In our next blog post on “Establishing Best Practices for Extending Credit in Today’s Economy,” we will more fully explore best practices for ensuring prompt payments.