This chapter outlines the foundational methodological framework necessary before delving into the practical aspects of credit risk and collection management. It establishes a structured approach to understanding and implementing strategies within these fields, emphasizing the importance of a well-thought-out methodology to guide practical actions and decisions. This preparation is crucial for professionals aiming to effectively manage credit risks and enhance collection processes, ensuring a comprehensive understanding of the principles and practices that underpin successful outcomes in these areas.
To illustrate conceptually, the organization can be likened to an athlete’s body. An athlete trains their body to perform high-intensity sports activities. They cannot settle for the standard heart-lung function of an average person but must enhance their physical training in their chosen sport, including fitness training, so their respiratory and circulatory systems operate at maximum efficiency during physical exertion. This enables them to handle the intensive physical activity required for their achievements.
Similarly, cash flow to an organization is like the oxygen supply to an athlete striving for excellence in sports. The organization must ensure that its credit and collection activities with its customers are managed in the most efficient and sophisticated manner possible. This is essential to provide the necessary cash flow for the organization’s operations and obligations and enable its growth. This is precisely the task of the organization’s manager and the credit and collection risk manager. They are responsible for ensuring efficient management of credit and collections systems – anticipating potential risks, assessing their outcomes, and mitigating them to ensure the uninterrupted supply of “oxygen” vital to the organization.
Management of credit and collection processes in the light of the “customer experience”
Managing credit and collection processes in light of “customer experience” is crucial. The operation of credit risk management and collection enforcement processes is intimately linked to the customer experience throughout their interactions with the organization—from the moment the customer first encounters the organization and becomes an actual client through receiving the product to the completion of the collection cycle. Inefficient or uncoordinated credit and collection control systems within an organization can lead to customer attrition at any stage, with all the implications that entail.
This perspective emphasizes the importance of viewing credit and collections not just as financial operations but as integral parts of the customer journey, highlighting the need for these systems to function efficiently and in harmony with other organizational processes to support and enhance customer retention and satisfaction.
“Customer Experience” (CX) is a term borrowed from the customer service domain, denoting the entirety of experiences a customer undergoes throughout their business relationship with a provider of products or services. In this website, we adapt and focus on the term “Credit and Collection Experience” of the customer, meaning the collection of experiences related to all credit and collection processes the customer encounters (the range of organizational activities represented by this term will be defined in more detail in the following chapter).
This perspective broadens the understanding of customer experience to include the product or service delivery and the financial interactions—credit and collections—that are part of the customer’s journey with the organization. It highlights the importance of managing these financial processes in a way that contributes positively to the overall customer experience, ensuring that they are seamlessly integrated into the broader spectrum of customer interactions.
From a strategic business perspective, “Customer Experience” is crucial for completing the initial transaction successfully and for “customer retention” for repeat purchases. Furthermore, the departure of an unsatisfied customer could lead to additional customer losses. It’s essential to remember that credit and collection systems encompass policies, processes, and cross-organizational procedures requiring coordination and integration among all process participants—from executives and owners to warehouse staff and delivery personnel. Actions must be efficient, effective, and prioritized in areas directly impacting the customer and their overall relationship with the organization, aiming to maintain them as a loyal and satisfied customer who recommends and attracts more customers.
Thus, this website gives special attention to the aspect of the customer’s “Credit and Collection Experience.” Generally, this website advises examining the “Customer Experience” in credit and collections in light of the organization’s overall vision and business strategy, ensuring maximum alignment. If misalignments are identified, it suggests mapping out the discrepancies and formulating a practical action plan to improve the situation.
The management of credit and collection processes from an organizational standpoint
Efficient management of credit risks and collections significantly improves an organization’s profitability and cash flow. Profitability is achieved by reducing the proportion of bad debts relative to the organization’s turnover. It also stems from maintaining low overall costs of credit and collection activities, measured against the industry or market standards in which the organization operates. This strategic approach ensures that organizations can enhance their financial health and sustainability over time by effectively managing credit risks and collection processes.
Improving profitability and cash flow can also be achieved by properly managing customer credit risks and monitoring credit terms offered, including controlling the organization’s exposure to market risks (economic and sector-specific) and through effective collection process management. An organization that does not adequately manage its credit risks and collections will likely face liquidity issues, consequently focusing more on securing immediate cash flow for operations. This focus can lead to less future planning, reduced innovation in new products, and lower investment in research and development. Moreover, there’s a reasonable chance that the organization may delay payments to its suppliers, with all the implications that may entail.
Most importantly, managing credit risks and collections must be done while maintaining maximum sales volume and meeting the organisation’s business objectives.
The Credit-to-cash cycle
We can introduce a parallel concept of the “Credit to Cash Cycle” in organizations by drawing an analogy to an athlete’s respiratory and circulatory system. This cycle involves the organization using cash to produce business output and selling this output in exchange for a promise of future cash payment (credit). After collecting the payment, which includes the cash equivalent of the product’s cost and profit, the organization recycles a portion of the received cash to produce additional products and generate more profits.
This process is depicted in the following diagram:
Diagram 8: The Credit and Collection Cycle in an Organization (Credit to Cash Cycle).
Here’s a condensed explanation of several new terms introduced in the diagram (more details will be presented in the following chapters):
- Customer Acquisition: This term encompasses all processes related to attracting a customer – from the initial marketing exposure, through identifying potential customers, ordering, requesting credit, approving the credit framework (credit control), to the sale, delivery, and billing.
- Account Receivables Management: Refers to managing all the organization’s customers, including collections from customers who pay according to agreed payment terms.
- Doubtful Debt: A debt or part of it is considered doubtful after assessing the debtor’s financial situation, and the organization’s management (or someone authorized by it, such as the CFO/Finance Manager/Accountant/Collection Manager) determines there is significant difficulty in collecting the debt and it is unlikely to be collected. It must be accounted for as a provision/expense in the organization’s books.
- Hard Collection Management: This term does not appear in the professional lexicon. It refers to collections from non-compliant payers – through intensified and assertive activities by the organization’s collection arms and, if necessary, through collections usually made in good faith by a lawyer or collection agency.
- Cash at Risk: Describes the customer’s debt from the moment the repayment period has passed and the debt has become overdue. The customer’s obligation is now for immediate repayment.
- Bad Debts: A debt owed by a customer to the organization which is unlikely to be collected despite all possible collection efforts. A bad debt is recognized as an expense, subject to income tax regulations.
- Cash Recovery (Collection): The term denotes the point in time when the organization collects the debt from the customer, thereby recovering the funds invested to make the sale to the customer.
The credit and collection department interfaces with parties within and outside the organization.
The Credit and Collection Department has numerous interfaces with various entities both within and outside the organization. The credit risk and collection manager’s responsibility is crucial in identifying, supporting, controlling, and managing all activities related to credit and collection processes. This includes activities derived from the organization’s agreed-upon credit and collection policy and those that indirectly impact the area. The table below details the main interfaces within the organization and externally:
| Main interfaces with departments within the organisation | Main interfaces with entities outside the organisation |
| 1. Management | 12. Customers |
| 2. Marketing | 13. Banks |
| 3. Sales | 14. Credit card companies |
| 4. Orders and provisioning | 15. Payment processors |
| 5. Receivables accounting and treasury | 16. Law firms (collections) |
| 6. Operations | 17. Credit rating agencies |
| 7. Customer care | 18. Credit risk insurers |
| 8. Legal department | 19. Collections agencies |
| 9. IT | 20. Skip tracing companies |
| 10. Internal audit | 21. Tax authorities |
| 11. Security officer | 22. External audit |
NEXT: Main interfaces with departments within the organisation
NEXT: Main interfaces with entities outside the organisation