Getting started with credit management and decisioning

The right approach to credit management and decisioning varies based on several factors, including:

• Scale: The more credit a company extends, the more rigorous its processes for managing credit decisions and receivables should be.
• Customer concentration: A business that sells a $100,000 piece of equipment to 10 customers each month typically does far more due diligence on each customer’s creditworthiness than one selling a $10 product to 100,000 customers each month.

Growing companies often start by dedicating a person or team to collections—building processes to help ensure receivables arrive on time and keep cash flow predictable.     

Credit decisioning involves two key components:

• Setting standard terms: Determine the terms your business can afford. For example, if extending credit for 60 days means paying additional interest on a working capital line of credit, that liquidity cost should factor into your pricing. Opportunity cost can be harder to measure but is still important to consider.
• Assessing customer creditworthiness: Request financial information that can help you evaluate a potential customer’s ability to cover payments. For public companies, financial records and credit ratings from agencies such as S&P Global Ratings or Moody’s can be useful resources. For a private company, you can request financial information directly or conduct a credit check with the company’s bank. “A credit check doesn’t provide detailed numbers, but it gives you some comfort that the business is in good standing with its bank and has sufficient liquidity to pay its debts,” Puro said.

Your J.P. Morgan banker can be a resource as you build credit processes. When Puro’s team works with a business seeking a working capital line of credit, it evaluates the business’s cash conversion cycle and major customers’ creditworthiness, then offers insights.

“We walk them through our processes, help them evaluate their large customers and share what we’re seeing,” Puro said.

Signals to reassess your company’s credit management

Companies often reevaluate their credit processes when experiencing cash flow challenges. An increase in overdue payments may indicate a company is extending too much credit to the wrong customers or failing to follow up on invoices. Persistent working capital shortages, meanwhile, may point to overly generous terms.

It’s also smart to proactively review credit decisioning, management and collection processes when:

• Preparing for significant cash outflows: When you’re planning to reinvest in the business—for example, by building a new facility or hiring a new team—predictable cash flow is even more critical.
• Taking on a major customer: A big customer is a big opportunity, but one that requires extra due diligence. Whenever a customer accounts for a significant share of revenue, missed payments can be catastrophic. “We have seen businesses fail because of one client that didn’t pay. That’s how critical this is,” Puro said.
• Scaling sales: If you pay your vendors on 30-day terms but extend 60-day terms to your customers, growth means taking on more debt to cover the gap.

When there’s a mismatch in the timing of incoming and outgoing payments, many companies prefer covering cash flow gaps with working capital loans to tightening terms, Puro said.

“If you have a healthy balance sheet, using working capital financing to maintain your terms can give you a competitive advantage over companies that can’t match those terms,” he said.

Strengthening credit management and decisioning

These best practices can help strengthen your credit processes:

1. Allocate resources

Weigh the cost of hiring a person or team dedicated to collecting receivables against potential savings from reducing days sales outstanding.

“There’s a cost associated with putting someone in that role, but there’s a cost to not doing so, too,” Puro said. “Every day you have receivables outstanding, you’re either paying interest to the bank to bridge the working capital gap, you have less cash in your account earning interest or you have less ability to reinvest liquidity.”

In addition to dedicating resources to collecting receivables, your finance team should include someone who can provide companywide oversight of decisions affecting credit management and cash flow. If the sales team is offering generous terms to win deals while procurement is accelerating payments to build supplier relationships, siloed decisions can create a working capital crunch.

“As you grow, it becomes important to have someone with full visibility across the working capital cycle building the right controls into the sales and procurement departments,” Puro said.

2. Don’t chase revenue

Strong credit management and decisioning processes only work if your team follows them consistently and holds all customers to the same standards.

“We sometimes see that when a company isn’t having a great year or quarter, they deviate from those standards to grow the customer base,” Puro said. “That’s where people run into trouble.”

3. Address missed payments promptly

Review outstanding invoices regularly to identify past-due payments and follow up quickly. A one-week delay might seem easy to brush off, but the effects cascade quickly: strained cash flow, delayed payments to your vendors and potential damage to supplier relationships. Have policies in place to determine when to continue selling to a customer with overdue payments and when to halt orders to avoid increasing your exposure.

In addition to following up on past-due payments, watch for changes in payment trends. If a customer who used to reliably pay each Tuesday is now pushing payments to the end of the week, it could signal financial challenges.

4. Be cautious with big customers

“If you’re taking on the biggest customer you’ve ever taken on, there’s a big exposure there,” Puro said. “We see clients struggle when working with customers whose size and scale give them power.”

In addition to conducting thorough due diligence, consider strategies for managing credit while building the relationship:

• Create a path to additional credit as the customer demonstrates reliability. For example, a company might extend a customer’s payment deadline from 30 days to 60 after six consecutive months of timely payments.
• Offer a discount if the company meets an early payment deadline. Savings from reducing receivables outstanding may offset the discount you offer to incentivize faster payment.