“Weak Souls Strengthened”

This day’s reading:

Romans 8:12, 13
Credit and Collection Policy
School of Business | 2nd Semester 2022-2023 | Jimuel Faigao | February 7, 2023
What are Credit & Collection?

A credit and collections policy is a

document that includes “clear, written
guidelines that set the terms and
conditions for supplying goods on credit,
customer qualification criteria, procedure
for making collections, and steps to be
taken in case of customer delinquency”.
In fewer words, it is a guide offering an organized
and repeatable philosophy on selling on the rules,
regulations and credit and collections procedures
to manage daily operations.

The goal for a credit collections plan is to clearly

define these elements so that sales and collections
employees conform to documented steps and
procedures designed to optimize your resources,
reduce credit risk, and improve overall cash flow.
Basic Outline for Developing a Credit Policy

Credit Policy is a set of principles that

a financial organization or business uses
in deciding who it will loan money to or
give credit to.
Basic Outline for Developing a Credit Policy

A credit policy, however, should be more

than a list of credit department
guidelines. Properly developed, it can be
a critical tool for maintaining alignment
on credit issues throughout your
company.
Basic Outline for Developing a Credit Policy

A well-written, comprehensive credit policy

communicates a consistent standard to your
customers. It documents and supports
corporate goals, clarifies authorization levels,
defines expectations and responsibilities and
enhances cross-functional cooperation
especially between the credit and sales
departments.
A well written and comprehensive
credit collection policy will:

✓ Ensure continuity in the department in the event that

key personnel leave the credit department.
✓ Help make sure all customers are treated fairly.
✓ Ensure consistent credit decisions are being made.
✓ Be used as a training tool for new sales associates
and the credit and collections team.
✓ Be used to ensure consistency of procedure and
execution between the credit department, sales,
and management.
Some of the major points from the study
include:

•19% said they review and adjust their policy every 2

years.
•13% said they review and adjust their policy every 3
years.
•15% reported they only review and adjust their policy
when they need to.
•12% said “other” which really makes you wonder the
last update took place.
Value of Credit & Collection policy

Effectively managing accounts receivable is about

ensuring consistency in your credit and collection
processes. The secret to this consistency is designing
and actively implementing a credit and collection
policy. Properly constructed and applied, this policy has
the power to breathe new life into your entire credit-to-
cash process. An old policy, however, that hasn’t been
reviewed under the current conditions may be doing your
company more harm than good.
 Develop a mission statement

A thoughtfully designed mission statement is

basic to a functional credit and collection
policy. It should express the long-range focus
of the policy and define the purpose of the
credit department.
 Define and set goals

Credit department goals for the coming year

should be included in the policy. Goals should
track with current market conditions and the
strategic direction of your organization. They
should be reviewed and updated annually.
Days sales outstanding
(DSO) is a measure of the
average number of days
that it takes a company
to collect payment for a
sale. DSO is often
determined on a
monthly, quarterly, or
annual basis.
DSO
= Accounts Receivable
Total Credit Sales

× Number of Days​
Current Percentage
calculates the
percentage of
receivables that are
current.

Formula:
Current AR ÷ Total AR
Collection
Effectiveness Index

Formula:
Beginning Receivables
+ Monthly Credit Sales
– Ending Total Receivables
Aging Bucket
Performance
The term aging bucket refers
to a grouping of unpaid
receivables by their credit
extension timeframe. Aging
buckets are used not only to
track the performance of a
company's collection
practices but also to
forecast write off.
Calculation:

Cash Collected per

Aging Bucket

= Total Cash Collected

/ Total Bucketed
Receivables
Bad Debt is the sum of
all outstanding
invoices that are
considered
uncollectible, meaning
that you don’t ever
expect to get paid for
them.
The following tasks are helpful in preventing bad
debts:
➢ Running all customers through a
prequalification process
➢ Recognizing red flags in customer conversations
➢ Performing annual file reviews
➢ Protecting and enforcing your mechanics lien
rights
➢ Reducing credit line exposure for non-active
customers
 Measure to manage

Goals must be linked to targets in order to

function as drivers for the improvement of
accounts receivable management. As such, they
need to be monitored and measured against
established metrics. Goals and performance
against goals should be communicated on a
regular basis to the entire credit organization.
Use the ‘5 C’s of Credit’ to help measure
against your organization’s goals

1. Character – Willingness to pay

2. Capacity – Will they keep it
3. Capital – Do they have it
4. Collateral – What backs it up
5. Conditions – Status of the current economy
 Clarify Departmental Responsibilities
and Focus Resources
Credit and Collection Departments are generally
composed of:
➢ Corporate Credit Manager
➢ Regional Credit Manager
➢ Collection Specialist
➢ Credit Analyst
➢ Credit Investigator
➢ Clerk
Evaluate a Credit Evaluation Process

➢ 3 Basic Ratios for Credit Evaluation

1. Quick Ratio:

(Cash + AR + Cash Equivalents) ÷ Current

Liabilities
Evaluate a Credit Evaluation Process

3 Basic Ratios for Credit Evaluation

2. Degree of Leverage Ratio:

Total Liabilities ÷ Net Worth

Evaluate a Credit Evaluation Process

3 Basic Ratios for Credit Evaluation

3. Profitability Ratios: Set of measurements
designed to determine a company’s ability
to create earnings
a. Contribution Margin Ratio:
(Sales – Variable expenses) ÷ Sales
Evaluate a Credit Evaluation Process
3 Basic Ratios for Credit Evaluation
3. Profitability Ratios: Set of measurements
designed to determine a company’s ability to
create earnings
b. Gross Profit Ratio:
(Sales – (Direct materials + Direct Labor +
Overhead)) ÷ Sales
Evaluate a Credit Evaluation Process

3 Basic Ratios for Credit Evaluation

3. Profitability Ratios: Set of measurements
designed to determine a company’s ability to
create earnings
c. Net Profit Ratio:
(Net profit ÷ Net sales) × 100
Evaluate a Credit Evaluation Process

Other Ratios for Credit Evaluation Process

Times Interest Earned Ratio:
Earnings before tax ÷ interest expense
Collection Period Ratio (days):
(Accounts receivable × 365) ÷ Net sales
DSO Ratio:
Accounts receivable ÷ Average sales per day
To make these decisions, organizations will
typically leverage:

✓ Industry credit groups

✓ Credit bureau reports
✓ Financial statements
✓ Credit references
✓ Public records
✓ Other information obtained directly from
the applicants
Evaluate a Credit Evaluation Process

➢ Financial Statement: Shortcomings

1. Time: Financial statements show position on a
specific date., and a statements that are
“current” at times may be 2-14 months old. If
the numbers show a weak financial condition at
the balance sheet date, it’s best to get bank and
trade references.
Evaluate a Credit Evaluation Process

➢ Financial Statement: Shortcomings

2. Determination of Trends: One year’s financial
statements is not enough.

3. Audited/Unaudited Statements: Audited are

best, though you will likely receive unaudited
statements.
Evaluate a Credit Evaluation Process
➢ Systemize Collection Procedures
This section should include:
✓ When to contact a customer
✓ How to contact a customer
✓ When to place an account on credit hold
✓ How to resolve disputes, deductions, etc.
✓ When to turn over delinquent accounts to an outside
collection agency
✓ When to write an account off to bad debt
Evaluate a Credit Evaluation Process

➢ Establish Terms of Sale

Including the terms of sale in the credit policy
sets up guidelines that allow for quick,
consistent decision making at the time of sale,
and in determining when the account falls due.
Evaluate a Credit Evaluation Process
➢ Keep the Momentum – Keep it Relevant
A credit and collection policy creates a structured
environment that can safeguard your organization’s most
precious asset – accounts receivable. Formulating such a
policy, however, is not a one-time effort. In order for it to
maintain its relevance and continue to have a positive
impact on cash flow and revenues, it must be routinely
updated in response to the changing economy, market
conditions, and competitive environment.