Credit planning and control

Credit planning

A credit planning is to set out procedures for defining and measuring the credit-risk exposure within the Group and to assess the risk of losses associated with credit extended to customers, financial investments and counter party risks with respect to derivative instruments. The main aspects of a credit planning are- 

1) the terms and conditions on credit, 

2) customer qualification criteria, 

3) procedure for making collections, and 

4) steps to be taken in case of customer delinquency.

Important Factors / Components are to be taken in consideration by a bank in formulating a credit planning or lending operational policy of a bank.

An effective Credit planning should includes the following:

Ø  Objectives of the credit function

Ø  Opening procedures and obtaining information for new accounts

Ø  Assessing & evaluating the proposals

Ø  Terms and conditions

Ø  Authority levels and responsibilities

Ø  Invoicing procedures

Ø  Monitoring borrowing and paying behavior of customer

Ø  Procedure relating to complaints and disputes

Ø  Targets, benchmarks, and deadlines for the credit function

Ø  Defining & collecting of dues, overdue and bad debts

The credit planning should be considered by internal and external factors and should be reviewed on an ongoing process. These are:

Ø  Type of industry

Ø  Competitors’ offers

Ø  Type of products or services provided to customers

Ø  Production and warehouse management

Ø  Distribution systems

Ø  Credit terms from trade suppliers and the bank’s overdraft limits

Ø  Costs of third parties involved, such as factoring, debt collection agencies, etc

Credit control

Credit control is the system used by a business to make sure that it gives credit only to customers who are able to pay, and that customers pay on time. Credit control is part of the Financial controls that are employed by businesses particularly in manufacturing to ensure that once sales are made they are realised as cash or liquid resources.

Credit Control is a critical system of control that prevents the business from becoming illiquid due to improper and un-coordinated issuance of credit to customers or even lending in a Financial institution. Credit control has a number of sections that include - credit approval, credit limit approval, dispatch approvals and well as collection process.

In a large business a credit process will be run by a senior manager and will include processes as such as Know Your Customer(KYC), Account Opening, Approval of credit and credit limits (both in terms of the amounts and the terms e.g. 30 Days, 30 Days net), Extension of Credit and effecting collection action.

Credit Control will normally report to the Finance Director or Risk Management Committee.

Procedures for Issuing credit

During the selling process a potential customer or even a current customer who pays cash may request for credit lines to be extended. At this point the following process may be followed:-

1. Formal letter of application for credit to be extended to a customer entity

2. Head of Finance evaluates the credit requested

3. Risk managers evaluate if the credit fits in with the current risk portfolio

4. Credit Collection period (usually in Days) is considered both as a stand alone and as a component of the working capital cycle in particular ensuring that it does not exceed the Payables Period ( usually in Days too).

5. External rating agencies may be invoked to assess the risk attached to extending credit to the customer. Usually credit worthiness of a firm may be assessed independently by firms such as Dan & Braadstreet, Bloomburge, AC Nielsen or other reputable firms.

6. Fillers are also made into the market to assess the creditworthiness of a firm

7. An internal evaluation is made considering the risk of Bad or Doubtful Debts against the profit or returns.

8. After Risk Manager & Finance Director is satisfied that the extension of credit will not result in loss of principal. Credit is extended!

9. An account is opened with the credit setting set for the agreed terms - Cap of Credit the Customer will enjoy and the terms or duration which they will enjoy that credit. In other words the time-limit as well as the value of the credit are sides of the same coin.

Managing Credit Extended

Once extended credit terms have to be rigorously applied and followed up on a regular basis-

 1. Dispatch ( in manufacturing ) cease to collect cash on delivery

2. A statement of account is generated on a regular basis showing all the customer details including credit limit and the status of each invoice - past due, due or not due. Typically the statement of account will be split in credit buckets that will follow the terms : Current, 30 Days, 60 Days, 90 Days & 180 Days.

3. Invoices must be kept to support the statement of account should a dispute arise.

4. A Reconciliation is typically done on a regular basis to ensure that both the supplier and customers have booked the same items and reconcile any booking differences.

5. Checks are collected on a regular basis against the statements with a remittance advice that shows exactly what invoices have been paid for.

6. One booking entries the paid invoices are matched so that they cease to appear on the Statement of account.

7. If the customer does not pay on time a call is made to follow up the credit.

Uncollectibility of Extended Credit

Extended credit could, despite all efforts made, become uncollectible. In this case a professional Debt collection agency may be hired along with attendant legal, court and other fees. This event is normally dreaded and most Chartered Accountants are reluctant to consider that credit extended has now become uncollectible necessitating a Debt write off if the Receivable has gone bust or a provision if only a lower amount can ultimately be collected.

Risk of credit

Unwarranted Debt may be a serious strain on the company and could lead to company failure. Many SMEs have failed due to unsatisfactory Debt Collection processes or procedures. During the credit crunch many businesses experienced a serious credit risk and severely curtailed extension of credit to partner firms and businesses. Even though the current situation is much less severe credit extension remains a key, pivotal role in business management.