Keeping control of credit - Units: 15 (CMCC)

Getting credit can be vital for small businesses, but it’s just as important for the supplier to ensure that their credit control system is robust, as Philip Dunn explains

Unit 15: Cash Management and Credit Control Systems is included in both the Diploma pathway Advanced Certificate stage and the Technician level of the NVQ route. Elements 15.3 and 15.4 cover the granting of credit and monitoring and control of the collection of debts, and trainee accounting technicians preparing for assessment in the skills’ test need to develop competence in this important area of working capital control.

The management of debtors presents the accountant with a trade-off situation, that of the cost of credit in the form of financing, the incidence of bad debts and administrative overheads versus the benefits of offering credit facilities, increased volume of turnover and ultimately greater profitability. In the two elements referred to earlier, three factors that are prominent:

• establishing a credit policy;
• implementing a credit policy; and
• monitoring the credit system.

When establishing a credit policy, the management will consider a number of influences, including:

• the business’ products and its position in the market;
• the terms offered by its competitors;
• the inherent risk of bad and doubtful receivables;
• the costs of financing the facility; and
• the overheads associated with administering the credit control system.

The implementation stage includes a number of functions that form the core of the policy. There is the need to assess the creditworthiness of prospective customers, control credit limits, ensure that invoices and statements are timely and establish procedures and internal controls to cope with the collection of funds from debtors.

What, then, are the vetting procedures that underpin the assessment of the creditworthiness of a prospective customer?

Bank references

Often an approach is made to the customer’s bank with their permission, but experience suggests that banks are often reluctant to give adverse references.

Trade references

The potential customer is required to supply references from at least two of their existing suppliers. Reliance on these is questionable, however, as the customer may only give references from those with whom they have a good payment record.

Credit agencies

These are organisations such as Dun & Bradstreet which, for a registration fee, will supply up-to-date reports on the ownership, control and financial stability of a business.

Financial statement analysis using performance indicators

The accounts of the prospective customer are obtained and assessed for profitability, liquidity, utilisation and financial stability (gearing/leverage).

Sales staff

Information from the company’s own staff can often indicate how well a prospective customer is performing and managed. For example, when Polly Peck reported both illusory turnover and profits before its collapse in the early 1990s, one of the administrators said of its subsidiary companies in Cyprus: “If only someone had gone and had a look, they would have realised that not all was well.”

Credit scoring

This is used more often on private individuals where a company makes direct sales to the public.

Further factors

Once the vetting procedure is complete, then consideration is given to the factors of setting credit limits, the credit period, settlement discounts and potential interest or credit charges. The credit limit and credit period will be influenced by the assessment made of the prospective customer’s current business activity, its financial stability and previous credit history.

Monitoring and the establishment of internal control are vital to the efficient working of a credit control system. This is influenced by a number of operational factors, including the timely issue of invoices and statements, following up overdue accounts by making telephone calls and sending reminder letters, and the use of collection agencies.

If the adverse ageing of debts occurs, it may be necessary to place certain customers ‘on stop’ by withholding supplies to speed up the collection of overdue funds. Often, the final step in the procedure may be the need to resort to legal action. Experience suggests that a solicitor’s letter often induces payment, and that court action is not usually effective.

Linked to the aspects of monitoring and control is the supply to management of timely and accurate reports in the form of an aged debtors’ list and analysis, the use of ratios as debtor days and a full analysis of causes of potential default. This part of the procedure is a function that the accounting technician must ensure is effective and efficient, as it influences management decisions that result in corrective action on a timely basis, and this affects the overall control of working capital in an organisation.

Philip Dunn FMAAT is a lecturer and author