THE IMPORTANCE OF STRATEGIC CREDIT MANAGEMENT WITHIN
THE FINANCIAL FUNCTION OF AN ORGANISATION
CARINA VAN ZIJL
SHORT DISSERTATION
Submitted in partial fulfillment of the requirements for the degree
MAGISTER COMMERCII
in
BUSINESS MANAGEMENT
in the
FACULTY OF ECONOMIC AND MANAGEMENT SCIENCES
at
RAND AFRIKAANS UNIVERSITY
STUDY LEADER: PROF. A. BOESENKOOL
NOVEMBER 2004
1
DEDICATION
To my husband Willem who gave beyond the call of duty throughout my studies and
to my two sons, Andrè and Travis - who made it possible and worthwhile.
2
ACKNOWLEDGEMENTS
I would like to express my sincere gratitude to the following people for their
assistance:
Prof. Aart Boesenkool, Lecturer at RAU University, for his assistance and guidance in
supervising this research.
Charity van Buren-Schele, my friend and collogue, for taking care of my Credit
Management I, II, and III students while I was working on this dissertation.
3
SUMMARY OF THE STUDY
Strategic functional management is the approach a functional area takes to achieve
corporate- and business unit objectives and strategies by maximizing resource
productivity. It is concerned with developing and nurturing a distinctive competence
to provide a company or business unit with a competitive advantage (Wheelen,
2002:160). The credit function, with debtors as the largest current asset on the
balance sheet, is such a functional area that should be concerned with providing the
organisation with a competitive advantage. Although many generic organisational
strategic models are available, there is a lack of guidelines on how to mange the credit
function strategically.
The objective of this research was to develop a framework, which could be used by
credit managers as a management tool, to select those aspects of the credit function,
which are relevant for an organisational strategic role. In order to achieve this goal,
the following sub objectives have been identified in which the framework should
enable credit managers to:
scan the credit function's external and internal
environments to keep in touch with opportunities and threats and to determine
strengths and weaknesses, and to formulate, implement and evaluate credit and
collection strategies that could contribute to organisational strategic goals.
A literature study method was used to collect data to be incorporated in the
development of this framework that will serve as basis for the alignment of strategic
credit management principles with strategic organisational principles. The focus of
4
the proposed framework was to use and adapt the four basic elements of Wheelen's
organisational model (Wheelen, 2002:2) into a more specific model applicable for
credit functions.
It was concluded that a competitive advantage could be obtained by the use of this
proposed strategic credit management framework. Credit managers should be trained
on how to use this framework effectively and then ensure that it is implemented,
evaluated, monitored and controlled on an ongoing basis. However, the applicability
thereof in practice is reserved for future studies.
5
TABLE OF CONTENTS
CHAPTER 1 ..................................................................................................................................... 9
ORIENTATION ............................................................................................................................ 9
1.1
Background ................................................................................................................. 9
1.2.
Problem Formulation................................................................................................. 11
1.3.
Research Purpose ...................................................................................................... 11
1.4.
Research Methodology............................................................................................... 12
1.5
Limitations................................................................................................................. 12
1.6
Chapter Outline ......................................................................................................... 12
CHAPTER 2 ................................................................................................................................... 14
LINK BETWEEN ORGANIZATIONAL STRATEGY AND STRATEGIC CREDIT MANAGEMENT
.................................................................................................................................................... 14
2.1
Introduction............................................................................................................... 14
2.2
Wheelen’s organisational strategic management model .............................................. 15
2.2.1
2.2.2
2.2.3
2.2.4
2.2.5
2.3
2.4
Environmental scanning .......................................................................................... 16
Strategy formulation................................................................................................ 16
Strategy implementation.......................................................................................... 17
Evaluation and control............................................................................................. 17
Feedback/learning process....................................................................................... 17
Strategic Credit Management framework ................................................................... 18
Summary.................................................................................................................... 19
CHAPTER 3 ................................................................................................................................... 14
EXTERNAL ENVIRONMENTAL SCANNING.......................................................................... 14
3.1
Introduction............................................................................................................... 14
3.2
Credit function’s external environment....................................................................... 15
3.3
Societal Environment ................................................................................................. 16
3.3.1
3.3.2
3.3.3
3.3.4
3.3.5
3.3.6
3.4
Operating Environment.............................................................................................. 19
3.4.1
3.4.2
3.4.3
3.4.4
3.4.4.1
3.4.4.2
3.5
Economical Factors................................................................................................. 16
Techonological Factors ........................................................................................... 17
Natural or ecological Factors ................................................................................... 18
Political-legal Factors.............................................................................................. 18
Social Factors ......................................................................................................... 18
International Factors................................................................................................ 19
Comptetive position ................................................................................................ 20
Customers profile.................................................................................................... 21
Suppliers................................................................................................................. 22
Human resources..................................................................................................... 23
Reputation .............................................................................................................. 23
Availability of Skills and Education......................................................................... 23
Summary.................................................................................................................... 24
CHAPTER 4 ................................................................................................................................... 26
INTERNAL
4.1
4.2
ENVIRONMENTAL SCANNING............................................................................ 26
Introduction............................................................................................................... 26
Resource-based view (RBV) approach........................................................................ 27
4.2.1
4.2.2
What makes a resource valuable?............................................................................. 28
Using resources to gain competitive advantage......................................................... 29
4.3
SWOT Analysis .......................................................................................................... 29
4.4
Value-chain analysis.................................................................................................. 33
4.3.1
4.4.1
4.4.1.1
4.4.1.2
4.4.1.3
4.4.1.4
strategic factors analysis (sfas) matrix...................................................................... 30
Conducting a value chain analysis............................................................................ 35
Identify Activities .................................................................................................. 35
Allocate Costs........................................................................................................ 35
Identify the Activities that Differentiate the Firm..................................................... 36
Examine the Value Chain ....................................................................................... 36
6
4.4.1.5
4.5
4.5.1
4.5.2
4.5.3
4.5.4
4.6
4.7
Compare to Competitors......................................................................................... 36
Structure.................................................................................................................... 37
Credit function Structure ......................................................................................... 37
Structure of a Financial Institution ........................................................................... 39
Decentralized - controlled at head office .................................................................. 40
Decentralised - staff at principal office..................................................................... 41
Culture ...................................................................................................................... 42
Summary.................................................................................................................... 43
CHAPTER 5 ................................................................................................................................... 45
STRATEGY FORMULATION ......................................................................................................... 45
5.1
Introduction............................................................................................................... 45
5.2
Mission Statement...................................................................................................... 46
5.2.1
5.3
5.3.1
5.3.1.1
5.3.1.2
5.3.1.3
5.3.1.4
5.3.1.5
5.3.1.6
5.3.1.7
5.3.1.8
5.3.2
5.4
Strategy types ......................................................................................................... 54
Marketing strategy ................................................................................................. 54
Financial strategies................................................................................................. 54
Research and development strategies ...................................................................... 55
Operations strategy................................................................................................. 55
Purchasing strategy ................................................................................................ 56
Logistics strategy ................................................................................................... 56
Human resource strategy ........................................................................................ 56
Information systems strategy .................................................................................. 56
Policies...................................................................................................................... 57
5.5.1
5.5.1.1
i)
ii)
iii)
iv)
5.5.1.2
5.5.2
5.5.2.1
5.5.2.2
5.5.2.3
5.5.2.4
5.5.2.5
5.5.2.6
5.5.2.7
5.5.2.8
5.5.2.9
5.6
Tactical Objectives.................................................................................................. 48
Keep up to date with influences in the environment................................................. 49
Increased sales and income ..................................................................................... 49
Keep the cost of extending credit as low as possible ................................................ 49
Reduce the risk of credit......................................................................................... 50
Improve the business’s cash flow............................................................................ 50
Keep the business’s bad debts to a minimum........................................................... 50
Liaise with other departments in the business .......................................................... 51
Improve customer relations..................................................................................... 51
Operational objectives............................................................................................. 51
FUNCTIONAL STRATEGIES .................................................................................... 52
5.4.1
5.4.1.1
5.4.1.2
5.4.1.3
5.4.1.4
5.4.1.5
5.4.1.6
5.4.1.7
5.4.1.8
5.5
Mission Formulation ............................................................................................... 46
OBJECTIVES ............................................................................................................ 47
Determinants of trade credit policy .......................................................................... 57
Market based factors ............................................................................................... 57
Competitive position .................................................................................................. 57
Industry credit terms................................................................................................... 57
Customer base............................................................................................................ 57
Finance available ....................................................................................................... 58
Credit Function Environment.................................................................................. 58
Policy fundamentals ................................................................................................ 59
Credit screening (vetting) ....................................................................................... 59
Conditions of sale................................................................................................... 59
Credit terms ........................................................................................................... 60
Credit risk reduction and credit insurance................................................................ 61
Risk categories and credit limits (Credit line) .......................................................... 61
Monitoring the policy............................................................................................. 62
Collection of Accounts ........................................................................................... 62
Credit Standard ...................................................................................................... 63
Invoice discounting ................................................................................................ 63
Summary.................................................................................................................... 63
CHAPTER 6 ................................................................................................................................... 65
STRATEGY IMPLEMENTATION .................................................................................................... 65
6.1
Introduction............................................................................................................... 65
6.2
Who implements strategy?.......................................................................................... 66
6.3
Programs, Budgets and Procedures............................................................................ 66
6.3.1
6.3.2
6.3.2.1
6.3.3
6.3.3.1
Programs ................................................................................................................ 66
Budgets .................................................................................................................. 68
Types of budgets.................................................................................................... 68
Procedures .............................................................................................................. 69
Investigating Procedure .......................................................................................... 69
7
6.3.3.2
6.3.3.3
6.3.3.4
6.4
6.5
Analysing Information Procedure ........................................................................... 69
Decision-making Procedure..................................................................................... 70
Collection Procedures............................................................................................. 70
Staffing...................................................................................................................... 71
Leading ..................................................................................................................... 72
6.5.1
Managing culture .................................................................................................... 72
6.5.1.1 Assessing strategy-culture compatibility .................................................................... 73
6.5.1.2 Manage culture through communication..................................................................... 74
6.5.2
Action planning...................................................................................................... 74
6.5.3
Management by objectives (MBO) .......................................................................... 75
6.5.4
Total Quality Management ...................................................................................... 75
6.6
Summary.................................................................................................................... 77
CHAPTER 7 ................................................................................................................................... 78
STRATEGY EVALUATION AND CONTROL ..................................................................................... 78
7.1
Introduction............................................................................................................... 78
7.2
Performance measures............................................................................................... 79
7.2.1
7.2.1.1
7.2.1.2
7.2.1.3
7.2.1.4
7.2.2
7.3
7.4
Balanced Scorecard................................................................................................. 80
Financial Performance Measures ............................................................................. 81
Customer Performance Measures............................................................................ 91
Internal Process Performance Measures .................................................................. 92
Innovation and Learning Performance Measures ...................................................... 93
Benchmarking......................................................................................................... 93
Guidelines for proper controlL................................................................................... 94
Summary.................................................................................................................... 95
CHAPTER 8 ................................................................................................................................... 97
RESULTS, CONCLUSION AND RECOMMENDATIONS........................................................................... 97
8.1
Results....................................................................................................................... 97
8.2
Conclusion................................................................................................................. 98
8.3
Recommendations ...................................................................................................... 99
BIBLIOGRAPHY...................................................................................................................... 101
8
CHAPTER 1
ORIENTATION
1.1
BACKGROUND
Strategic management is that set of managerial decisions and actions that determines
the long-run performance of a corporation.
It emphasizes the monitoring and
evaluating of external opportunities and threats in light of a business’s strengths and
weaknesses (Wheelen, 2002:4)
Strategic functional management is the approach a functional area takes to achieve
corporate and business unit objectives and strategies by maximizing resource
productivity. It is concerned with developing and nurturing a distinctive competence
to provide a company or business unit with a competitive advantage (Wheelen,
2002:160). The credit function, with debtors as the largest current asset on the
balance sheet, is such a functional area that should be concerned with providing the
organisation with a competitive advantage.
Slow payment and a high proportion of bad debt will defeat the whole business
objective. Everyone in the company works hard to market the product or service,
achieve sales targets, produce and deliver the product or service, maintain high levels
of customer satisfaction and try to obtain payment. If payment is made late, then
profitability is eroded. If payment is not made at all, then a total loss is incurred! On
that basis, it is simply good business to put credit management at the ‘front end’ by
managing it strategically (Barry, 1997;i).
9
Professor Nick Wilson of Bradford
University, and his research team reported the following: Firms who devote more
time to ‘front-end’ credit management perceive late payment to be less of a problem,
have a significantly higher proportion of invoices paid on time and have a lower
proportion of bad debts (Barry, 1997:i). The weight of the corporate world is now
shifting to the credit function’s shoulders, and savvy credit managers should seize the
opportunity to demonstrate how they can strengthen their company’s financial
position (Cleaver, 2002:30). It is therefore a perfect time for consultants and credit
executives to reposition the credit function as a key driver of corporate profitability
and growth.
The question can then be asked how managers and corporate executives view the
contribution of strategic credit management to the success of their firms. Barry
(1997:Preface) means that credit management is seen in many businesses as simply a
matter of debt chasing. Edwards (1997:xxv) wrote that credit management is still
regarded in many organisations as solely the collecting of overdue debts, often by
junior staff without the authority to negotiate problem cases. Jurgen (2002:26) says,
that even thought the importance of receivables management is undisputed, many
companies do not consider it to be part of their core activities. Shaw (2003:18) wrote
that too many business owners think of their credit and finance operations as backoffice functions. But, debtors is probably one of the biggest assets on a business’s
balance sheet that need professional management.
Accounts receivable for strategic management must operate successfully in the
changing, evolving environment of the organisation if it is to make a positive
contribution to the financial aspect of this strategic analysis, planning and control
10
process. It is therefore necessary to select which aspects of the credit function are
relevant for this strategic role. In other words, long-term objectives of the credit
function must be derived from and/or linked to the strategic plan of the organisation.
1.2.
PROBLEM FORMULATION
A comprehensive literature review and discussions with experts in the credit industry
revealed that the process on how to select those credit function aspects, which are
relevant for the strategic role is not clear. Credit functions are therefore usually
managed on an operational basis. Although many generic models are available to
assist executives to plan strategically for the organisation, the problem is the absence
of guidelines on how to manage the credit function strategically. In other words,
guidelines on how to move from an organisational strategy to a credit function
strategy that will contribute to the overall success of the organisation.
1.3.
RESEARCH PURPOSE
The aim of this study is to develop a framework which credit managers could use as a
management tool to select those aspects of the credit function which are relevant for
the strategic role.
In order to achieve this goal, the following sub objectives have been identified in
which the framework should enable credit managers to:
•
scan the credit function’s external environment to keep in touch with
opportunities and threats in the credit industry;
11
•
scan the credit function' internal environment to determine the strengths and
weaknesses of the credit function;
•
formulate, implement and evaluate credit and collection strategies to contribute
to organisational strategic goals.
1.4.
RESEARCH METHODOLOGY
A literature study method was used to collect data to be incorporated in the
development of a framework that will serve as basis for the alignment of strategic
credit management principles with strategic organisational principles.
This
framework is based on the basic steps of a generic model of strategic management.
1.5
LIMITATIONS
The limitations set for this study is that the suggested framework is developed to be
tested in the South African credit industry. The focus is more on credit functions
within businesses rather than the banking industry.
1.6
CHAPTER OUTLINE
The final report will be divided into the following chapters:
Chapter 2 discusses how to link the strategy of the credit function within a business
with the organizational strategy.
12
Chapter 3 discusses how to scan the external environment in search of possible
opportunities or threats.
The focus of chapter 4 is on internal environmental scanning to determine the
strengths and weaknesses of the credit function.
Chapter 5 deals with middle management formulating a strategy by means of the
development of a mission, medium-term objectives, strategies and policies.
Chapter 6 deals with the implementation of a strategy where strategies and policies
are put into action through the development of programs, budgets and procedures.
Chapter 7 discusses the process of strategy evaluation and control in which credit
function activities and performance results are monitored so that actual performance
can be compared with desired performance.
Chapter 8 concludes with the results, conclusion and recommendations of this study.
13
CHAPTER 2
LINK BETWEEN ORGANIZATIONAL STRATEGY AND
STRATEGIC CREDIT MANAGEMENT
2.1
INTRODUCTION
The primary objective of any business is to maximize owner’s welfare, in other words
"getting paid". Because business is basically concerned with the sale of goods or
services on open account at profit, the credit function plays an important, pivotal role
within the organisation. The credit function is the link between customers and many
other business functions such as marketing, sales, production, shipping, customer
service and accounts payable. It contributes to the common primary objective of
maximizing profit by means of an increase in credit sales and the net income from
sales by granting credit. Slow payment and a high proportion of bad debt will defeat
the primary business objectives. If payment is made late, then profitability is eroded.
On that basis, it is simply good business practice to put credit management at the
"front end" which will produce real benefits.
The credit function represents a business decision that requires both financial and
strategic decision-making to assure that a proper balance of benefit is derived from
sales against carrying the cost or potential loss.
The attainment of an appropriate match or “fit” between an organisation’s strategy
and its credit function strategy has positive effects on the organisation’s performance.
However, as mentioned in the previous chapter, despite the availability of numerous
14
models on how to manage an organisation strategically, there is a lack of guidelines
on how to manage the credit function strategically. Put differently, on how to move
from an organisational strategy to a credit function strategy.
This chapter therefore proposes a framework to close this gab between the credit
function strategy and organisational strategy. The proposed framework is based on
the basic steps of Wheelen’s organisational strategic model (2002:10).
This chapter will briefly discuss the main components of Wheelen’s organisational
strategic model. It will then look at possible adjustments on how to make it more
applicable for credit functions, after which the proposed model will be illustrated.
2.2
WHEELEN’S ORGANISATIONAL STRATEGIC
MANAGEMENT MODEL
According to Wheelen (2002:2), strategic management is that set of managerial
decisions and actions that determines the long-run performance of a corporation. As
illustrated in Figure 2-1, it includes the following four basic elements and how these
elements interact:
15
FIGURE 2-1: Basic Elements of the Strategic Management Process
Environmental
Scanning
Strategy
Formulation
Strategy
Implementation
Evaluation
and Control
Source: Adapted from Wheelen & Hunger, 2002:9
2.2.1 ENVIRONMENTAL SCANNING
Wheelen’s first step, environmental scanning, is to monitor, evaluate and disseminate
information from the external and internal environments to key people within the
organisation.
Wheelen suggests conducting environmental scanning through the
SWOT analysis.
Key external environmental variables to be evaluated may be general forces and
trends within the overall societal environment or specific factors that operate within
an organisation’s specific task environment.
Wheelen furthermore suggests evaluating key internal environmental variables such
as an organisation’s structure, culture and resources.
2.2.2 STRATEGY FORMULATION
Wheelen’s second step is strategy formulation where long-range plans are developed
for the effective management of environmental opportunities and threats, in light of
16
corporate strengths and weaknesses.
It includes defining the corporate mission,
specifying achievable objectives, developing strategies and setting policy guidelines.
2.2.3 STRATEGY IMPLEMENTATION
Wheelen suggests a third step namely strategy implementation where strategies and
policies are put into action through the development of programs, budgets and
procedures.
2.2.4 EVALUATION AND CONTROL
The fourth step suggested by Wheelen is evaluation and control, a process to monitor
corporate activities and performance results so that actual performance can be
compared with desired performance.
2.2.5 FEEDBACK/LEARNING PROCESS
Wheelen’s model also includes a feedback/learning process where decisions made
earlier in the model can be revised or corrected.
Accounts receivable for strategic management must operate successfully in this
changing, evolving environment if it is to make a positive contribution to the financial
aspect of this strategic analysis, planning and control process.
It is therefore
necessary to select which aspects of the credit function are relevant for this strategic
role.
17
2.3
STRATEGIC CREDIT MANAGEMENT FRAMEWORK
Credit management aspects necessary for this strategic role could also be regarded as
an integrated credit management approach drawing together all the individual
elements involved in analyzing, formulating, implementing and controlling a chosen
credit function strategy. The credit function is still part of the larger organisation and
must align its strategic process with that of the organisation as a whole.
By understanding the long-term goals of the organisation, the credit manager can set
long-term goals for the credit function ("where it wants to go") to contribute towards
the organisation's goals. Therefore there must also be a comprehensive analysis of the
environment in which the credit function is and will be operating ("where it is"). In
order to conduct this environmental scanning, (as in Wheelen’s model), the SWOT
analysis is also suggested.
This analysis must furthermore include all the internal operations and resources of the
credit function, but equally important, must cover the external aspects of its
environment.
This need to include, and indeed concentrate on these many factors which are external
to the credit function is a major element which separates strategic credit management
from the more operational processes of credit and collection management.
The combination of "where the credit function is" and "where it wants to go" to
contribute to overall business success, will normally identify the need for a series of
actions to bridge the gaps between the two or even merely to maintain the same
18
position if the external environment is changing adversely. Certain practical credit
and collection strategies must be developed and implemented in the context of the
internal and external environments to bridge these gaps.
It is thus clear that Wheelen’s four basic elements for managing the organisation
strategically are also necessary and applicable in the strategic role of the credit
function, but with a more specific credit industry approach. These four elements are
therefore used as the basis for the development of a proposed strategic credit
management framework as depicted in Figure 2.2.
2.4
SUMMARY
A framework to assist credit managers to manage the credit function more
strategically was thus suggested. This framework is based on Wheelen’s (2002:5)
strategic model but with a few adaptations to make it more applicable for a credit
function, for example:
The first step in Wheelen’s model discusses the Societal- and Task external
environments and focus then on resources, structure and culture in the internal
environment. The proposed Credit Management framework discusses the external
environment in terms of Societal- and Credit Management Operating environment.
Both models discuss factors such as resources, structure and culture to scan the
internal environment, but with a more practical approach for the credit industry.
19
The second step, Strategy formulation, in both the proposed framework and
Wheelen’s model focus on the mission, objectives, strategies and policies. However,
the application thereof will be more practical orientated for the credit industry.
Implementation, Wheelen’s third step, discusses programs, budgets and procedures
whereas the proposed framework suggests tactics, budgets, procedures, staffing and
leading.
The final step in both the existing- and the proposed model focus on the measurement
of performance and guidelines for proper control.
20
Reason for
existence
Mission
What results
to accomplish
by when
Objectives
Broad
guidelines
for decision
making
Policies
21
Feedback/Learning
Plan to
achieve the
mission and
objectives
Strategies
Strategy Formulation
Proposed Strategic Credit Management Framework
Source: Adapted from Wheelen & Hunger, 2002:1
Culture
Beliefs, expectations,
value
Structure
Chain of command
Resources
Recourse-based View,
Value Chain
Internal
Operating Environment
Industry analysis
Societal Environment
General forces
External
Environmental
Scanning
Figure 2.2:
Activities
needed to
accomplish a
plan
Tactics
Cost of the
programs
Budgets
Sequence of
steps needed
to do the job
Procedures
Strategy Implementation
Performance
Process to monitor
performance and
take corrective
action
Evaluation
and Control
CHAPTER 3
EXTERNAL ENVIRONMENTAL SCANNING
3.1
INTRODUCTION
According to Wheelen (2002:52), an organisation must scan the external environment to
identify possible opportunities and threats before it can begin to formulate a strategy.
Important factors from the societal environment that could influence the organisation’s longrun decisions are for example economic-, technological-, political- and sociocultural forces.
Information gathering and analyzing all relevant elements in the operating environment is also
for top management to use in strategic decision making.
Because the credit function is a key driver of corporate profitability, credit executives at
functional level need to make tactical decisions which are aligned with top management
decisions. In order to do that, they have to know what the possible opportunities and threats
are in the external environment. The credit function’s external environment is both the
immediate environment within the organisation such as other departments as well as
happenings in the credit industry.
The first step of the suggested framework is therefore also described as Environmental
Scanning with the same headings. However, the focus is on opportunities and threats from
the entire credit industry as well as other functions within the company which might have an
influence on the credit function.
The next section in this chapter will discuss external environmental scanning in terms of the
credit function’s societal and operating environment.
14
3.2
CREDIT FUNCTION’S EXTERNAL ENVIRONMENT
The external environment consists of variables (Opportunities and Treats) that are outside the
credit function and not typically within the short-run control of the credit manager. These
variables form the context within which the credit function exists within the organisation.
They may be general forces and trends within the overall societal environment or specific
factors that operate within the credit function’s specific operating environmentalso called
the credit industry.
In undertaking environmental scanning, credit managers must be aware of the many variables
within the credit function’s societal- and operating environments. The societal environment
includes general forces that do not directly touch on the short-run activities of the credit
function but that can influence its long-run decisions. These are as follows:
•
Economic conditions affect how easy or difficult it is to be a successful and profitable
credit function because it affects both capital availability and cost of credit (Thompson,
1997:247). These economic forces regulate the paying behaviour of customers, and the
delivery of a credit service and information.
•
Technological forces that generate problem-solving inventions.
•
Political-legal forces that allocate power and provide constraining and protecting laws
and regulations for the credit function.
•
Socio-cultural forces that regulate the values, morals and customs of society.
The operating environment includes those elements or groups that directly affect the credit
function, and in turn, are affected by it. These are government, local communities, suppliers,
competitors, customers, employees/labor unions and special-interest groups.
The credit
function’s operating environment is typically the credit industry within which the credit
function operates.
15
Industry analysis refers to an in-depth examination of key factors within the credit function’s
operating environment. Both the societal and operating environments must be monitored to
detect the strategic factors that are likely to have a strong impact on success or failure of the
credit function. This analysis takes the form of individual reports written by various people in
different parts of the credit function and other departments in the organisation. These reports
are then summarized and transmitted for credit executives to use in functional strategic
decision making.
3.3
SOCIETAL ENVIRONMENT
The number of possible strategic factors in the societal environment is very high. The number
becomes enormous when we realize that, generally speaking, each credit function in the world
can be represented by its own unique set of societal forces.
3.3.1 ECONOMIC FACTORS
Trends in the economic part of the societal environment can have an obvious impact on credit
activities. For example, an increase in interest rates will result in fewer debtors to settle their
accounts on time. Debtors might also pay less than the minimum due. Why? Because a
rising interest rate tends to be reflected in higher mortgage rates, which in turn increase the
cost of paying installments on house mortgages. This decreases the ability of the debtor to
pay as his disposable income has decreased.
Factors in the economic environment that the credit manager should monitor are: availability
and cost of credit, disposable and discretionary income, exchange rates, inflation rates and
interest on credit.
16
These factors are interrelated and influence each other. High inflation rates caused by high
exchange rates (which make imports more expensive), leads to higher interest rates which
slows down the economic growth of a country. The availability of credit also serves to effect
changes in the economic growth.
3.3.2 TECHNOLOGICAL FACTORS
Changes in the technological part of the societal environment can also have a great impact on
credit industries. For example, new and improved software programs are reflected in new
means of credit service delivery, productivity improvements through automated credit
application and automated credit scoring models, on-line credit related courses offered to
employees
The credit manager must continually monitor the technological changes in the industry. There
are two ways of taking this into account. On the one hand, the credit manager can decide to
stay with an old tried and tested system and reap the benefits of lower costs of technology.
Lower cost can be an important competitive advantage. On the other hand the credit manager
can always update his systems to always use the most up-to-date systems. This will lead to
higher technological costs, but it will provide the discerning client the best service at a
premium.
Examples of important technological variables that the credit manager must always be aware
of are skills level of the workforce, information flow infrastructure, and regulations on
technology transfer.
17
3.3.3 NATURAL OR ECOLOGICAL FACTORS
The processes and functions of a credit function pose no threat for the environment. The
involvement of the organisation in environmental affairs will reside with corporate
management, and therefore the credit manager will in no way be involved in the environment.
3.3.4 POLITICAL-LEGAL FACTORS
Trends in the political-legal part of the societal environment have a significant impact on
credit functions.
For example enforcement of certain credit related laws such as the
Insolvency Act, Prescription Act, Consumer Credit Act, Data Protection Act; Bills of Sales
Act and many more.
The political factors determine the legal and regulatory boundaries within which an
organisation must operate. Some laws and regulations restrict the potential profits of an
organisation, while others protect and benefit organisations. These laws have an important
influence on the organisation.
The government also exercises a demand as well as a supply function. The credit manager
will be engaged in transactions with the government if the organisation is involved in the
supply of services to the government.
3.3.5 SOCIAL FACTORS
The social environment encapsulates demand and tastes, which vary with disposable income.
The credit manager must be aware of demographic changes as the structure of the population
by affluences and regions can have an important bearing on the demand for credit service
(Thompson, p248).
18
3.3.6 INTERNATIONAL FACTORS
Businesses that operate internationally find themselves in a far more complex environment
because each country has unique environmental factors which differ from those of other
countries.
A company’s credit policy, or lack of one, is vital to the success or failure of its international
marketing programme. The fact that a credit customer is located in a foreign country does not
alter the basic principles and procedures of sound credit management.
International forces such as the following, needs to be examined by the credit manager when
his organisation decides to go global or is already a multinational corporation and decides to
seek credit customers (van Zijl:26): credit problems with international customers, type of
government dealing with in foreign country, economic stability of foreign country, currency
and exchange rate of currencies, credit business practices of the foreign country, and
collection procedures of foreign accounts.
3.4
OPERATING ENVIRONMENT
The operating environment comprises factors in the competitive situation that effect the credit
department’s success in acquiring needed resources or in profitably marketing the credit
service. Among the most important of these factors are the credit function’s competitive
position, the composition of its customer, its reputation among suppliers and its ability to
attract capable employees (Pears et al:98). Thus, firms and credit departments can be much
more proactive in dealing with the operating environment than dealing with remote
environment.
19
3.4.1 COMPTETIVE POSITION
Assessing it competitive position improves the credit function’s chances of designing
functional strategies that optimize its environmental opportunities.
Development of
competitor profiles enables the credit function to more accurately forecast profit potentials.
Criteria such as the effectiveness of credit sales, credit terms, experience, credit and collection
policies, calibre of personnel and general images could for example be included in
constructing a competitor’s profile
Once appropriate criteria have been selected, they are weighted to reflect their importance to a
firm’s success. Then the competitor being evaluated is rated on the criteria, the ratings are
multiplied by the weight and the weighted scores are summed to yield a numerical profile of
the competitors as illustrated in Figure 3.1.
FIGURE 3.1: Competitor’s Profile
Key Success Factors
Weight
Rating*
Effectiveness of credit sales
Experience
Credit terms
Credit policy
Calibre of personnel
Total
0.30
0.20
0.20
0.10
0.20
1.00
4
3
5
3
1
Weighted
Score
1.20
0.60
1.00
0.30
0.20
3.30
*The rating scale suggested is as follows: very strong competitive position (5 points), strong (4), average (3),
weak (2), very weak (1). The total of the weights must always equal 1.00
Source: Adapted from Pearce & Robinson, 2000:99.
20
3.4.2 CUSTOMERS PROFILE
Perhaps the most vulnerable result of analysing the operating environment is the
understanding of the credit department’s customers. Developing a profile of the present and
prospective customers improves the ability of the managers to plan strategically.
One of the advantages of credit management is that it builds and establishes long term
customer relations. (Kritzinger, 1997:132). At the same time it helps to enlarge the businesses
market share and it maximises the business’s profitability. Focusing on good customer service
will enable the credit function to reach these objectives. Good customer service is often the
only competitive advantage that distinguishes between two businesses. The business has to
compete with other businesses by retaining existing customers and give these customers the
best possible service. It is cheaper for the business to retain its customers than to open new
accounts for new customers.
Credit customers mainly come from three sources (Cole & Mishler, 1998:161):
New customers – Irrespective of the kind of credit the business provides, new customers will
result in a greater volume of credit sales. Sources of new customers include cash customers
who have not previously used credit, potential customers living in the community and new
residents. The challenge here is that new customers must be convinced that the business’s
credit program is better than those they already have.
Inactive customers – these are the customers that have a credit card, but have not charged
anything to it for several months. The business has already expended funds and energy in the
approval process and now the challenge is to regain the customer’s confidence and loyalty.
21
Active customers – These are customers that are already using the business’s credit program.
The challenge here is to convince the customer to increase the use of his credit card, either by
switching from cash purchases to credit purchases or by possibly consolidating other debt by
increasing the loan amount with your business.
Businesses are also constantly losing established customers and gaining new customers due to
divers reasons. These are (NACM, 2000:362): mergers of businesses, relocation of the
customer, changes in business functions and services, technological changes, discontinuing of
an unsatisfactory relationship, change on the financial status of individual customers, and
other non-financial reasons.
The credit manager needs to adjust to all these changes to ensure that the credit function
continues to play an important part in the value chain of the business.
Credit functions should be in touch with their customers (debtors) to find out whether they are
satisfied/not satisfied with the service rendered, why they are not satisfied, what suggestion
do they have, etc. In other words, the credit function must find ways to improve the service it
renders to the customer.
3.4.3 SUPPLIERS
Dependable relationships between a credit department and its credit related supplier services
are essential to the firm’s long-term survival and growth (Pears, 2000:103). Suppliers can
affect the credit industry through their ability to raise prices or reduce the quality of credit
services.
22
It is important that credit managers do research on what kind of credit related services his
department can make use off. For example the different credit bureaus offering services on
the gathering of information on new applicants, credit education, credit insurance, factoring
and invoice discounting, finance houses and leasing, credit card services and collection
agencies.
3.4.4 HUMAN RESOURCES
The credit department’s ability to attract and hold capable employees is essential to its success
(Pears, 2000:104). The access to needed personnel is affected primarily by two factors:
credit department’s reputation as an employer and the ready availability of people with the
needed skills and education.
3.4.4.1
Reputation
The credit department’s reputation within its operating environment is a major element of its
ability to satisfy its personnel needs. It is more likely to attract and retain valuable employees
if it is seen as competitive in its compensation package, concerned with the welfare of its
employees, and if it is respected for its service to the customer and other functions in the
company.
3.4.4.2
Availability of Skills and Education
The top-level credit executive must establish and maintain basic controls governing the
selection, compensation and development of department employees (NACM, 2000:57).
Adequate staffing ideally means that the right person is in the right job at the right time, at the
right compensation and with satisfaction to all concerned. For example, the person who posts
cash and reconciles accounts should be meticulous and thorough. However, the person who
23
must put all the reference material together for assessing a new account must not just be
thorough, but also have imagination and operate as a detective, accountant and salesperson.
The credit executive must ensure that his subordinates get the best training and education
which will contribute to the employee’s career path. UNISA for example offers short training
courses, a National Diploma- and a B Tech degree in credit management.
3.5
SUMMARY
Because the credit function is a key driver of corporate profitability, credit executives at
functional level need to make tactical decisions which are aligned with top management
decisions. In order to do that, they have to know what the possible opportunities and threats
are in the external environment. The credit function’s external environment is both the
immediate environment within the organisation such as other departments as well as
happenings in the credit industry.
Credit functions operate with external environments that spring surprises on them from time
to time. It can make sense for the credit function to see its boundary with the environment as
relatively fluid. While credit service suppliers, customers and other departments within the
organisation can be seen as outside the credit functional boundary, they can also be identified
as partners in a collaborative network which bounds with a number of external influences and
forces.
Credit functions must be able to react to the change pressures imposed by their environment
and at the same time, take advantage of opportunities, which seem worthwhile. Leading
credit executives will create and sustain positions of strength by seeking to influence and/or
manage their external environment.
24
The first step of the suggested framework is therefore also described as Environmental
Scanning with the same headings. However, the focus is on opportunities and threats from
the entire credit industry as well as other functions within the company which might have an
influence on the credit function.
25
CHAPTER 4
INTERNAL ENVIRONMENTAL SCANNING
4.1
INTRODUCTION
According to Wheelen (2002:82), an organisation must also look within the corporation itself
to identify internal strategic factors ─ those critical strengths and weaknesses that are likely to
determine if the firm will be able to take advantage of opportunities while avoiding threats.
Such a strength or weakness could be any of the departments of the organisation for example
the credit function.
As said in the first chapter, because the credit function is a key driver of corporate
profitability, credit executives at functional level need to make tactical decisions which are
aligned with top management decisions. In order to do that, they also have to identify internal
strengths and weaknesses that are likely to determine if the credit function in cooperation with
the other functions will be able to take advantage of opportunities while avoiding threats.
The suggested framework’s second part of the first step is therefore also described as Internal
Environmental Scanning with the same headings as Wheelen’s model such as resources
available, the current structure and the culture. However, the focus is on those elements
specifically applicable in the credit function as derived from the organisation’s strategic
elements.
To identify and examine internal resources of the credit function, this chapter will discuss
three approaches namely, the Resource-based view (RBV) analysis, the traditional SWOTanalysis and the Value Chain analysis.
26
In an organisation’s structure there is a direct line of authority from top to bottom. Workers
receive instructions from the immediate supervisor.
Line managers can use specialist
knowledge but can still decide whether or not to follow the advice or recommendations.
However, functional authority is enforceable in the credit function structure.
Specialist
knowledge is used and better co-operation with other departments leads to achieving the
organisation's objectives.
The credit functional culture differs from the organisational culture in the way that credit
members behave and the values that are important to them may and it dictates tactical
decisions to be made, tactical objectives as appose to organisational objectives, credit function
strategies and policies, attitudes towards managing employees and information systems.
For these reasons, resources, structure and culture is a central driving force in the suggested
framework of strategic credit management and discussed in detail in this chapter.
4.2
RESOURCE-BASED VIEW (RBV) APPROACH
The resource-based view’s (RBV) underlying premise is that credit functions differ in
fundamental ways because each credit department possesses a unique “bundle” of
resources─tangible and intangible assets and departmental capabilities to make use of those
assets.
Each credit department develops competencies from these resources and, when
developed especially well, these become the source of the department’s competitive
advantages (Pearce, 2000:194).
Central to RBV is the notion of three basic types of resources that together create the building
blocks for distinctive competencies, namely:
27
•
Tangible assets that you can touch for example debtor’s book, computers and financial
resources.
•
Intangible assets like the credit department’s reputation, the morale of the employees,
technical or credit management knowledge, accumulated experience in the field of credit,
cost of credit relative to that of competitors, relations with other departments and
customers, effective credit cost control, etc.
•
Departmental capabilities such as skills ─ the ability and ways of combining assets,
people and processes ─ that the credit department can use to transform inputs into
outputs. Examples are such as efficiency of credit application process, procedures to
monitor accounts, collection procedures, etc.
4.2.1 WHAT MAKES A RESOURCE VALUABLE?
Once credit managers begin to identify their department’s resources, they face the challenge
of determining which of those resources represent strengths or weaknesses─which resources
generate core competencies that are sources of sustained competitive advantage. The RBV
sets some key questions or guidelines that help determine what constitutes a valuable asset,
capability or competence ─ that is, what makes a resource valuable (Pearse, 2000:195).
•
Does the resource help fulfill the credit customers’ (debtors’) needs better than those of
the firm’s competitors?
•
Is the resource in short supply? When the credit department posses a resource which few
others do, and it is central to fulfilling customers’ needs, then it becomes a distinctive
competence.
•
Is the resource easily acquired or copied? A resource that competitors can easily copy is
only of temporary value.
•
How soon will the resource depreciate? The slower it depreciates, the more valuable it is.
Tangible assets, like the debtor’s book, can have their depletion measured. Intangible
28
resources, like departmental capabilities, present a much more difficult depreciation
challenge.
4.2.2 USING RESOURCES TO GAIN COMPETITIVE ADVANTAGE
Suppose that the credit department’s sustained competition advantage is primarily determined
by its assets, skills or competencies, a five step resourced-based approach to strategy analysis
can be used (Wheelen, 2002:83):
•
Identify and classify the department’s resources into strengths and weaknesses.
•
Combine the department’s strengths into specific capabilities. If these capabilities are
superior to those of competitors, they are distinctive competencies.
•
Evaluate these capabilities to determine their potential for sustainable competitve
advantage.
•
Develop plans that best exploit the department’s resources and capabilities.
•
Identify the gaps in the resources and upgrade weaknesses.
4.3
THE SWOT ANALYSIS
SWOT is an acronym for the internal Strengths and Weaknesses of a credit department and
the environmental Opportunities and Threats facing the credit department (Pearce 2000:202).
The SWOT analysis of the credit function should be carried out within the framework of the
entire organisation.
29
4.3.1 STRATEGIC FACTORS ANALYSIS (SFAS) MATRIX
As in Wheelen’s organisation model (2002:110), the External Factors Analysis Summary
(EFAS) and the Internal Factor Analysis Summary (IFAS) tables plus the Strategic Factors
Analysis Summary (SFAS) Matrix can also be developed and used as a powerful set of
analytical tools for strategic credit analysis. The SFAS summarizes the credit department’s
strategic factors by combining the external factors from EFAS table with the internal factors
from the IFAS table. Tables 4.1 and 4.2 list a total of 10 examples of possible internal and
external factors. The SFAS Matrix in Figure 4.1 requires the strategic decision maker to
condense these strengths, weaknesses, opportunities and threats into fewer than 10 strategic
factors. This is done by reviewing and revising the weight given to each factor. The revised
weights reflect the priority of each factor as a determinant of the department’s future success.
The highest weighted EFAS and IFAS factors should appear in the SFAS Matrix.
TABLE 4.1: EXTERNAL FACTOR ANALYSIS SUMMARY (EFAS)
External Strategic Factors
Weight
Rating
Weighted
Score
Comments
O1 New consumer information products
O2 New credit insurance products
O3 Declining interest rates
.15
.05
.10
5.0
4.2
3.9
.75
.21
.39
O4 International credit due to economic
development of Asia
.05
3.0
.15
O5 Degree in credit management
offered at UNISA
Threats
T1 Competitor’s good credit terms
T2 Strong competition
T3 Competitor strong globally
T4 New credit service advances in
industry
T5 Increasing government credit
regulations
Total Scores
.15
2.8
.42
Will investigate
Will investigate
Key to higher
debtors’ payments
Low company
(credit department)
presence
Will investigate
.05
.05
.15
.20
2.2
2.0
2.0
2.1
.11
.10
.30
.42
Weak in this area
Well positioned
Well positioned
Questionable
.05
4.0
.20
Will take time
Opportunities
1.00
3.05
Source: Adapted from Wheelen & Hunger, 2002:110.
30
TABLE 4.2: INTERNAL FACTOR ANALYSIS SUMMARY (IFAS)
Internal Strategic Factors
Weight
Rating
Weighted
score
Strengths
S1 Credit personnel relations
.20
4.1
.82
S2 Experienced managers
.10
5.0
.50
S3 Good relations with customers
.05
1.0
.05
S4 Industry related credit terms
.05
2.0
.10
S5 Information technology
.10
1.8
.18
Weaknesses
W1 International orientation
.10
4.3
.43
W2 Credit assessment
.10
4.0
.40
W3 Outsourcing
.15
3.0
.45
W4 Credit policy
.05
1.2
.06
W5 Cost of credit
.10
1.6
.16
Total Scores
1.00
3.15
Source: Adapted from Wheelen & Hunger, 2002:110.
31
Comments
Good but could
improve
Know the credit
industry
Good but
deteriorating
Benchmarking
recommended
Debtors’ days
reduced with 13
days
Poor international
credit experience
Not linked to
Information Bureaux
Investigate
possibility to
outsource collections
No proper policy in
place
High cost due to
increase from 30 to
60 days
FIGURE 4.1:
STRATEGIC FACTORS ANALYSIS SUMMARY (SFAS)
Key Strategic Factors
Weight
Rating
Weighted
Score
O1 New consumer information
products
O5 Degree in credit management
offered at UNISA
T3 Competitor strong globally
T4 New credit service advances in
industry
S1 Credit personnel relations
.10
5.0
.50
Will investigate
.10
2.8
.28
Will investigate
.10
.15
2.0
2.2
.20
.33
Well positioned
Questionable
.10
4.1
.41
S2 Experienced managers
.10
5.0
.50
S5 Information technology
.10
1.8
.18
W3 Outsourcing
.15
3.0
.45
W5 Cost of credit
.10
1.6
.16
Good but could
improve
Know the credit
industry
Debtors’ days
reduced with 13
days
Investigate
possibility to
outsource collections
High cost due to
increase from 30 to
60 days
Total Score
1.00
Select the most important opportunities/threats
from EFAS table and the most important
strengths and weaknesses from IFAS table.
Comments
3.01
Notes:
1.
List each of the most important factors developed in your IFAS and EFAS tables in Column 1.
2.
Weight each factor from 1.0 (most important) to 0.0 (not important) in Column 2 based on that factor’s probable impact on the credit
department’s strategic position. The total weight must sum to 1.00.
3.
Rate each factor from 5.0 (outstanding) to 1.0 (poor) in Column 3 based on the department’s response to that factor.
4.
Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4.
5.
Use Column 5 (comments) for rationale used for each factor.
Source: Adapted from Wheelen & Hunger, 2002:111.
As illustrated in Figure 4.1, a SFAS matrix can be created by following these steps:
•
Column one (Strategic factors) – list the most important IFAS and EFAS items in
terms of weight. Indicate whether it is a strength (S), a weakness (W), an opportunity
(O) or a threat (T) or a combination.
•
Column two (Weight) – enter the weights for all the internal and external factors that
have been entered into the matrix. Since the weights must still total 1.00, some of the
current weights will probably have to be adjusted.
32
•
Column three (Rating) - assign a rating of how well the credit management is
responding to each of these factors. These ratings will probably be the same as those
listed in the IFAS and EFAS tables.
•
Column four (Weighted score) – calculate the weighted score as done with the IFAS
and EFAS tables.
•
Column five (Comments) – repeat or revise your comments for each strategic factor
that has been transferred from the IFAS and EFAS tables.
The resulting SFAS matrix is a listing of the credit department’s internal and external
strategic factors in one table.
4.4
VALUE-CHAIN ANALYSIS
The strategic capability of a credit department is largely determined by the activities it
undertakes in designing, producing, marketing, delivering and supporting its service. The
value-chain analysis approach, developed by Porter, helps in understanding how these
primary and other support activities underpin a credit department’s competitive advantage. It
begins with the inputs necessary to deliver the service, covers the transformation of the inputs
into services and the delivery of these services to the customers, and finally ends with the
after credit-sales service the business has to provide to have a satisfied customer.
By breaking the various processes further down into activities, value-chain analysis gives
management a better insight into the internal workings of the credit department. It enables
credit managers to determine the strengths and weaknesses of each activity and to determine
how each activity contributes to the competitive advantage of the credit function. By doing
activity-based costing, the business can also add a value to each activity and therefore
determine where cost-advantages and cost-disadvantages exist
33
Support Activities
Support Activities
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Value Chain
FIRM’S INFRASTRUCTURE
Capability to identify new credit service opportunities and environmental threats
Quality of the strategic credit planning to achieve corporate objectives
Timely and accurate credit industry information
Relationships with credit interest groups
Public image
HUMAN RESOURCE MANAGEMENT
Effectiveness of procedures for recruiting, training and promoting all levels of credit employees
Appropriateness of reward systems for motivating and challenging employees
Work environment that minimizes absenteeism and keeps turnover at desirable levels
Active participation by credit personnel in professional organisations
Levels of employee motivation and job satisfaction
TECHNOLOGY DEVELOPMENT
Using of technology to execute activities in meeting critical deadlines
Success of research and development activities in leading to credit service and process innovations
Quality of computer systems or/and facilities used by credit controllers
Qualification and experience of credit controllers
Ability of credit work environment to encourage creativity and innovation
PROCUREMENT
Development of criteria for credit terms decisions
Good, long-term relationships with reliable suppliers such as Credit Bureaus, Credit Insurance,
Credit education, etc.
Procedures for procurement of all credit department equipment
Efficiency
• Productivity of
• Timeliness
• Effectiveness of • Means to
of credit
personnel
and
market research
solicit
application
compared to
efficiency of
to identify
debtors’ input
procedures.
that of key
delivery of
debtors
for credit
competitors
credit
service
Efficiency
• Innovation in
service
improvements
of credit
• Efficiency of
credit sales
• Promptness
worthiness
credit function
promotion and
evaluation
layout and
advertising
of attention to
procedures
work-flow
customer
• Motivation and
design
complaints
competence of
• Appropriate
• Quality of
credit sales force
automation of
customer
• Development of
credit
education and
an image of
assessment
training
quality credit
procedures
service and
• Soundness of
favorable
credit control
reputation
systems
Inbound
Logistics
Operations
Outbound
Logistics
Marketing
And Sales
Profit Margin
Figure 4.2
Credit
Service
Primary Activities
Source: Adapted from Porter:1988:35.
Figure 4.2 shows a possible value chain framework for a credit department. It divides
activities within the credit department into two broad categories:
primary- and support
activities. Primary activities are those involved in the creation of the credit service, in the
marketing and selling of the service to the customer, and in after-sales service support.
Support activities assist the primary activities by providing an infrastructure or inputs that
allow the primary activities to take place on an ongoing basis (Pears 2000:206). The value
34
chain also includes a profit margin since a markup above the cost of providing the
department’s value-adding activities is normally part of the price paid by the customer ─
creating value that exceeds cost so as to generate a return for the effort.
4.4.1 CONDUCTING A VALUE CHAIN ANALYSIS
4.4.1.1
Identify Activities
The initial step in value chain analysis is to divide the credit department’s operations into
specific activities or processes, usually grouping them similarly to the primary and support
activity categories.
The credit manager’s challenge at this point is to be very detailed
attempting to “disaggregate” what actually goes on into numerous distinct, analyzable
activities rather than settling for a broad, general categorization.
4.4.1.2
Allocate Costs
The next step is to attempt to attach costs to each discrete activity. Each activity in the value
chain incurs costs and ties up time and assets. Value chain analysis requires credit managers
to assign costs and assets to each activity. With an activity perspective, activities consume
resources and cost objects consume activities (Bromwich, 1996:64). This is in contrast to
traditional accounting where costs are consumed by cost objects. The focus is not on the
amount of each type of general ledger costs, such as wages, equipment, power and
supervision incurred by the credit department, but on the costs of the activities undertaken by
the department.
Figure 4.3 shows and example of an activity-based value chain analysis approach that would
provide a more meaningful analysis of the credit function’s costs and consequent value-added.
35
Figure 4.3: Activity-based Costing
Evaluate credit information capabilities
Process credit applications
Expedite credit information process
Expedite credit granting process
Check days-sales-outstanding
Resolve problems
Internal administration
Total
4.4.1.3
135,750
82,100
23,500
15,840
94,300
48,450
110,000
509,940
Identify the Activities that Differentiate the Firm
Scrutinize the credit department’s value chain may not only reveal cost advantages or
disadvantages, it may also bring attention to several sources of differentiation advantage
relative to competitors. Figure 4.2 suggests some factors for assessing primary and support
activities’ differentiation and contribution.
4.4.1.4
Examine the Value Chain
Once the value chain has been documented, credit managers need to identify the activities that
are critical to debtors’ satisfaction and credit industry success. It is those activities that
deserve major scrutiny in an internal analysis. For example, the credit department’s mission
needs to influence managers’ choice of the activities they examine in detail. If the focus is on
being a low cost of credit provider, then credit management attention to lower costs should be
very visible.
4.4.1.5
Compare to Competitors
The final basic consideration when applying value chain analysis is the need to have a
meaningful comparison to use when evaluating a value activity as a strength or weakness.
Value chain analysis is most effective when comparing the value chains or activities of key
competitors.
36
4.5
STRUCTURE
Although there are a large variety of structures, some structures tend to support certain
strategies better than others. It is therefore important for the credit function to choose the
correct structure to facilitate the implementation of the necessary strategy.
A change in the corporate strategy may lead to changes in the credit function’s organisational
structure or in the kind of skills that will be needed for new activities. The credit manager
should thus carefully evaluate his department’s structure and the new activities or changes in
operations that need to be undertaken to determine if any changes needs to be made the
department’s structure to accommodate the new activities. The credit manager may need to
answer the following questions:
Should more staff be taken into service? Should a change be made in the grouping of the
activities, or should a new section be formed? Should additional managers be appointed to
accommodate the additional activities? Should some of the activities be centralized to head
office? Should the structure be changed to make it more flat? Should the span of control be
adjusted?
Should the credit manager affect a radical redesign of its activities? (re-
engineering)? Should the job descriptions of staff be adjusted to meet the needs of the
strategy?
There are many similar issues the credit manager should give attention to. Changes in the
credit function strategy always lead to changes in the structure. Structure follows strategy.
4.5.1 CREDIT FUNCTION STRUCTURE
In a small business a person in the financial department may perform all the credit activities.
One person may be responsible for all the decisions in connection with granting of credit,
37
collecting debtors, opening new accounts, customer service, debtors control and all the
activities associated with credit management. However, as the business grows, all these credit
management activities become too much for one person to manage, or it becomes too much to
be managed in a department which has its own focus, like the financial department.
To manage the growing activities related to credit management, more people are employed by
the business. If growth persists, it will soon become necessary to establish a credit function.
To manage the diverse activities of a credit function it will soon become necessary to divide
the department into subdivisions. All similar tasks are then grouped together in subdivision.
The size or form of the credit management structure will depend on the size and activities of
the business. Figure 4.3 below shows a possible structure for a credit department (Kritzinger,
1997:115).
Figure 4.4: Credit Department Structure
CREDIT DEPARTMENT
New Accounts
Customer Service
Debtors Control
Payments
Collections
Source: Adapted from Kritzinger, 1997:115)
Each of these departments will have managers in charge that will be responsible to the head of
the credit function.
38
New accounts – applications for new accounts will be processed in this department. They will
also be responsible to notify applicants of the success or otherwise of their applications.
Customer service – the people in this department will be responsible for dealing with all the
enquiries by customers. Inquiries may include wrong entries on an account statement, entries
not shown on the statement, payments not reflected on the statement.
Payments – this department is responsible for processing all payments received from debtors.
Payments can be in different forms: cheques, postal orders, debit orders and in cash.
Debtors’ control – this department is responsible for all the activities pertaining to the
debtor’s ledger. It includes the control of debtors, balancing the debtor’s ledger, handling cash
refunds, and returned cheques.
4.5.2 STRUCTURE OF A FINANCIAL INSTITUTION
In a financial institution the credit function will be much more significant as the financial
institution is dependant on income from interest on loans, credit cards and mortgages for its
survival. They therefore have independent credit functions that could look like the example in
Figure 4.5 (Kritzinger, 1997:116).
39
Figure 4.5: Structure of a Financial Institution
BRANCH MANAGER
Export Manager
Supervisor:
New accounts
Credit Manager
Marketing Manager
Portfolio manager
Group of accounts: A-M
Portfolio manager
Group of accounts: N-Z
Supervisor:
Administration
Supervisor:
Collections
Clerk
Source: Adapted from (Kritzinger, 1997:116).
4.5.3 DECENTRALIZED - CONTROLLED AT HEAD OFFICE
Figure 4.6 shows an example of a structure where credit is controlled at a principal office, but
administered from decentralized locations (Principles, 2000:53):
Figure 4.6: Centralized structure, controlled at head office
TREASURER
DIVISION
GENERAL MANGER
TOP-LEVEL
Chief Credit Executive
MID-LEVEL
Chief Credit Executive
Credit Manager
40
Credit Manager
In this structure, the mid-management level chief credit executive reports to a top-level chief
credit executive at headquarters and also to a divisional general manager. The mid-level chief
credit executive receives his authority regarding credit and collection from the top-level chief
credit executive and is authorized by the division general manager regarding personnel
problems, operating expenses and all other non-functional matters within the scope of the
relevant policy.
4.5.4 DECENTRALISED - STAFF AT PRINCIPAL OFFICE.
Below is an example where credit is controlled and administered from decentralised locations
with a staff office maintained at headquarters.
Figure 4.7: Decentralized – Staff at principal office
VICE PRESIDENT
OPERATIONS
TREASURER
DIVISION
GENERAL MANAGER
TOP LEVEL
CHIEF CREDIT
EXECUTIVE
MID-LEVEL
Chief Credit Executive
MID-LEVEL
Chief Credit Executive
Credit
Manager
Credit
Manager
41
In this case the top-level credit executive is responsible for reporting to top management,
providing advice and counsel to line credit executives, and determines the overall credit
policies.
The division is responsible to carry out the credit policies of the business and is responsible to
the general manager for the performance of the function and for the operation of the division.
4.6
CULTURE
Credit function culture is the collection of beliefs, expectations, and values learned and
shared by a credit function’s members and transmitted from one generation of employees to
another. It determines the way the work is done in the department and gives the department a
sense of identity: “This is who we are. This is what we do. This is what we stand for”.
The culture of the credit department has two distinct attributes, namely intensity and
integration. Cultural intensity is the degree to which members of the credit function accept
the norms, values or other culture content associated with the credit function. This shows the
culture’s depth. Organisations and credit functions with strong norms promoting a particular
value have intensive vultures, whereas new firms/credit functions have weaker, less intensive
cultures. Employees in an intensive culture tend to exhibit consistent behavior, that is, they
tend to act cimilarly over time. Cultural integration is the extent to which units throughout
the organisation share a common culture.
Credit department culture fulfills several important functions: Conveys a sense of identity for
employees, helps generate employee commitment to something greater than themselves, adds
to the stability of the organisation and department as a social system, and serves as a frame of
42
reference for employees to use to make sense out of credit function activities and to use as a
guide for appropriate behavior.
Corporate and credit function culture shapes the behavior of people in the the credit function.
Because these cultures have a powerful influence on the behaviour of people at all levels, they
can strongly affect the credit function’s ability to shift its strategic direction. A strong culture
should not only promote survival, but it should also create the basis for a superior competitive
position.
What is very important is that a change in mission, objectives, strategies or policies will likely
not be successful if it is not supported by the culture in the department. Employees might
resist a radical change in the philosophy in the department. If the department’s culture is
compatible with the new strategy, it is an internal strength. Conversely if the department’s
culture is not compatible with the proposed strategy, it is serious weakness.
4.7
SUMMARY
According to Wheelen in the second part of his model’s first step, organisations have to
analyze all functions within the company to determine internal strengths and weaknesses that
are likely to determine if the firm will be able to take advantage of opportunities while
avoiding threats.
In order to do that, the credit function also need to look within the department itself to identify
specific credit function related strengths and weaknesses. Resources, structure and culture is
therefore also central driving forces in the suggested framework of strategic credit
management but from a functional point of view.
43
Resource analysis can be done through three approaches namely, the Resource-based view
(RBV) analysis, the traditional SWOT-analysis and the Value Chain analysis.
Culture is the way in which the credit function performs its tasks, the way its people think,
feel and act in response to opportunities and threats, the way in which functional objectives
are set and the way tactical decisions are made.
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CHAPTER 5
STRATEGY FORMULATION
5.1
INTRODUCTION
According to Wheelen, strategy formulation as part of the strategic planning process is
concerned with the development of the credit department’s mission, objectives, strategies and
policies. The mission reflects the essential purpose of the entire organisation, concerning
particularly why it is in existence, the nature of the business and the customers it seeks to
serve and satisfy (Thompson, 1997:89). Organisational objectives are long-term and the end
result of planned activities. They state what is to be accomplished by when and should be
quantified. Organisational strategy forms a comprehensive plan stating how the organisation
will achieve its mission and objectives. Organisational policy is a broad guideline for top
management decision-making that links the formulation of strategy with its implementation.
Individual functions like the credit function usually do not have their own vision since the
company’s vision statement is applicable for the entire organisation. When developing the
credit function’s mission, credit managers should keep the company’s mission in mind. The
mission of the company must thus direct middle (credit) manager’s thoughts (Rossoux,
2000:79).
Credit functional objectives are medium-term and derived from organisational objectives.
They are set by credit managers since they know exactly what is happening in and around the
division (Rossoux, 2000:2000).
45
Functional strategy is the approach taken by a functional area such as the credit function, to
achieve corporate and business unit objectives and strategies by maximizing resource
productivity. It is concerned with developing and nurturing a distinctive competence to
provide a company with a competitive advantage (Wheelen, 2002:13).
Functional policy, which is derived from organisational policy, provides specific guidelines
for middle (credit) management decision-making that links the formulation of credit function
strategy with its implementation.
The third step of the proposed framework therefore also focuses on the development of
medium-term mission statement, objectives, strategies and policies but by middle-managers.
5.2
MISSION STATEMENT
Whether a firm is developing a new- or reformulating direction for an existing credit
department, it must determine the basic goals and philosophies that will shape its strategic
posture. This fundamental purpose that sets a credit department apart from other firms’
departments of its type and identifies the scope of its credit service operations is defined as
the credit department’s mission.
It describes the credit department’s service, the
technological areas of emphasis and it does so in a way that reflects the values and priorities
of the credit department’s strategic decision makers.
5.2.1 MISSION FORMULATION
According to Wickham (2001:155), the strategic component of a mission statement could for
example include the following elements:
46
•
Service scope which specifies exactly what the credit department will offer to the
customers.
•
Customer groups served stipulating which customers and distinct customer groups that
will be addressed by the credit department.
•
Benefits offered and customer needs served which specifies the particular needs that the
customer groups have and the benefits that the credit department’s service offer to
satisfy these needs.
•
The innovation on which the credit department is based and the sources of sustainable
competitive advantage. This defines the way in which the department has innovated,
how it is using this to exploit the opportunity it faces and how this provides it with a
competitive advantage that can be sustained in the face of pressure from competitors.
•
Aspirations of the credit department defining what the department aims to achieve. It
indicates how its success will b measured.
5.3
OBJECTIVES
All the different activities that are carried out in the business are aimed at achieving the
primary objective of the business. The business’ primary objective is to obtain a maximum
return (maximize profitability) on the capital that the business has employed.
All the different departments of a business work together towards this common primary
objective namely maximum profitability. By means of credit sales (and the income from
these sales), the credit function makes a contribution to this common primary objective.
Although the objectives of the credit department are derived from their mission, they must
also support the organisational goals. Should the credit department’s mission be aligned to
47
the business’s mission, the objectives will ultimately contribute towards the goals of the
organisation.
The credit manager should develop medium-term objectives (tactical objectives) for a period
of two to three years. Two important requirements for tactical (departmental) objectives are
to be measurable and to be linked to time.
5.3.1 TACTICAL OBJECTIVES
The credit function strives to increase sales and net income from sales by granting credit.
However, the advantages of granting credit must be considered together with the
disadvantages and cost of credit.
The credit function tries to obtain a balance between the advantages of extending credit and
the cost that is involved. The cost of granting credit has a direct influence on the profit of the
business.
Credit management objectives can only be achieved if the business gives time and attention to
credit management. Dedicated staff members must be responsible for planning, carrying out
and controlling the credit and collection activities.
The credit manager is ultimately
responsible for all the activities involved in the granting of credit (such as approving credit
applications and determining credit limits) and collection of outstanding amounts.
Credit extension and collection must be managed in such a way that they make a real
contribution to higher profitability of the business. To achieve this, the credit manager and
his department must strive to achieve certain objectives. According to Kritzinger (1997:71),
credit management objectives are the following:
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5.3.1.1
Keep up to date with influences in the environment
The business and credit department functions in an environment where many factors influence
its daily activities such as: the business’s competitors (better credit services), suppliers
(information, legal, factoring or insurance), and debtors’ needs.
The general economic situation and international, political and legal factors also influence the
business. Rising interest rates, for example, may have a negative effect on new installment
credit contracts – the buyer will have to pay more interest and may therefore reconsider the
contract. Credit managers must be aware of these influences in the environment.
5.3.1.2
Increased sales and income
One of the main reasons why businesses sell on credit is to increase sales, income from sales
and profits. Credit facilities enable more people to buy the business’s products or services.
The credit manager is in an important position to increase sales but should attempt to keep the
cost of credit as low as possible (Cole 1998:24).
Financial institutions or banks grant credit for example in the form of loans, and attempt to
increase the volume of transactions. They earn thus an income from loans (in the form of
interest paid on these loans). The same applies to credit cards, where interest is paid on
outstanding balances.
5.3.1.3
Keep the cost of extending credit as low as possible
Extending credit inevitably involves cost. It is impossible to eliminate these costs completely.
The credit manager must therefore try to keep the different cost components as low as
possible.
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5.3.1.4
Reduce the risk of credit
There is a risk involved in extending credit as it is possible that the debtor will wait a long
time before paying the account and/or will not pay the account at all. The credit manager
must try to reduce this group of debtors and, if possible to eliminate them completely.
Objective credit assessments and effective guidelines for the collection of debts can reduce
the risk of granting credit.
5.3.1.5
Improve the business’s cash flow
Businesses invest money in the debtors that they acquire as a result of their credit sales.
Debtors paying their accounts result in a drop in the level of the debt owed to the business and
thus an increase in the level of the business’s cash. (This has a positive influence on the
business’s cash flow position).
However, the business itself also has obligations towards their creditors. Should the business
experience a cash flow problem, it becomes more difficult to meet these obligations in the
short term. This in turn influences the business’s liquidity position (the ability of the business
to make its own payments regularly and on time). The credit function thus plays an important
role in the business’s cash flow by collecting as soon as possible and by keeping outstanding
amounts to a minimum.
5.3.1.6
Keep the business’s bad debts to a minimum
Credit managers should try to write off as few debts as possible and collect debts that are in
arrears as soon as possible. The longer an account is outstanding, or the longer the credit
department waits to collect it, the more difficult it becomes resulting in higher risk of bad
debts.
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5.3.1.7
Liaise with other departments in the business
The credit function does not function in isolation but is multi-functional, interacting with
many other functions in the business. During the credit process, credit confers with the sales-,
the order entry-, production-, shipping-, accounting- and customer service departments
(NACM, 2000:40).
5.3.1.8
Improve customer relations
Credit sales provide the business with an opportunity to build long-term relationships with the
customers. Satisfied customers will return and spend more. This in turn will increase sales
and income from sales. It is thus very important that the credit function should provide an
excellent service to its customers.
5.3.2 OPERATIONAL OBJECTIVES
To achieve the general objectives of credit management, the credit function must set specific
operational objectives. Operational objectives are objectives that are set for the short term,
which is for a year or less. For example, higher sales and higher income from sales are
general objectives for the credit manager. To achieve this objective, the credit function has to
perform certain activities. It will help the department to achieve its general objective if they
open 500 new accounts every month and keep these accounts active.
Achieving the operational objectives contributes to the achievement of the general objectives
of credit management and of the business’s primary objective, as illustrated below.
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FIGURE 5.1 OBJECTIVES
OBJECTIVES OF THE BUSINESS
25% return on capital
OBJECTIVES OF CREDIT MANAGEMENT
Higher sales and higher income from sales
OPERATIONAL OBJECTIVES
500 new accounts each month
INDIVIDUAL OBJECTIVES
Every accounts clerk must open 50 new accounts
Operational and individual objectives of the credit function must meet certain requirements.
These objectives must be clear and unambiguous, motivating and challenging, achievable, in
line with the general objectives of the business, relevant, measurable and precise.
5.4
FUNCTIONAL STRATEGIES
Functional strategy is the approach the credit function takes to achieve functional and
corporate goals and strategies.
It focuses on developing and nurturing a distinctive
competence to provide the business with a competitive advantage. However the orientation of
functional strategy is dictated by the business’s strategy.
Many large firms have identified shareholder value as their primary goal, focusing on
maximizing long-term cash flow for each business unit within the company.
A key
assumption of shareholder value analysis (SVA) is that a business is worth the net present
value of its future cash flows, discounted at the appropriate cost of capital. In this way, SVA
provides a framework for linking management decisions and strategies to value creation. It
52
helps managers to focus on value-adding activities or value drivers. Figure 5.2 illustrates how
SVA can assist those involved in credit management as they seek to add value to the firm.
FIGURE 5.2: SHAREHOLDER VALUE FOR CREDIT
SHAREHOLDER VALUE ADDED (SVA)
Goal
Cost of Capital
Cash flow from
Operations
Cash flow from
Credit Sales
Value
Drivers
Sales growth, profit
margin, etc.
Cost of Funding
Credit
Investment in Accounts
Receivable
Credit Risk
Management
Credit Policy
Strategy
•
•
•
Investment
Strategy
Marketing credit
sales
Financing and
Risk Management
R&D
Operations
Purchasing
•
Logistics
•
Human Resources
•
Information
Management
Source: Adapted from Pike, 1998:17
The credit manager can add value by being actively involved in the development and
implementation of some of the following strategies.
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5.4.1 STRATEGY TYPES
5.4.1.1
Marketing strategy
It can for example develop new services strategies for existing customers or new services for
new customers.
With these strategies the business hopes to increase sales through developing its credit
offerings to attract new customers or increase the use of credit by existing customers.
5.4.1.2
Financial strategies
According to (Pike et al, 1998:46), trade debtors are normally classified as a current asset and
form part of working capital, together with stock and trade creditors. The financing strategy
for any company depends upon its ability to raise funds and its attitude towards risk.
Companies willing to take on more risk in order to improve expected profits may finance part
of the permanent working capital by short-term funds ─ often called an aggressive financing
strategy. Accounts receivable can therefore be a valuable vehicle for funding the credit
operation.
A wholly owned finance subsidiary – A business can establish a wholly owned finance
subsidiary to manage the credit operations and to obtain finance. An advantage of a separate
credit subsidiary is that it separates the financing arm of the company from the selling arm,
resulting in greater efficiency.
Credit cards – Credit cards can help the seller businesses to minimize funds tied up in debtors,
eliminate bad debt expenses and reduce credit administration costs.
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Factoring – a convenient financing method involving the transfer of title of the debtors, with
or without recourse, to the factor. The seller receives a discounted amount based on the face
value of the accounts factored.
Pledging receivables – refers to a loan obtained with the value of the debtors as security. As
with factoring, finance arrangement is also designed to release capital tied up with trade
debtors. Loans can be obtained from commercial banks and commercial finance companies.
Unlike factoring, the company is fully responsible for collecting the debt and bad debt risk.
Invoice discounting – loans can be arranged with specialist finance houses called invoice
discounters. A company can realize invoices immediately in cash up to 75% of the face value
of the invoices by placing those invoices as collateral security in return for a bill of exchange.
. The loan must be redeemed at the maturity date, and the cost involved is an interest charge
and service charge based on the risk and administration costs.
5.4.1.3
Research and development strategies
Research and development strategy deals with the credit service and process innovation and
improvement. It also deals with how the new technology should be accessed ─ internal
development or external acquisition.
5.4.1.4
Operations strategy
Operations strategy determines how and where the credit service is to be rendered and the
deployment of resources. It should also deal with the optimum level of technology the credit
department should use in its operations processes.
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5.4.1.5
Purchasing strategy
The credit department also needs supplies and equipment to perform its functions. The credit
function must decide if it will use multiple sourcing, sole sourcing or parallel sourcing.
5.4.1.6
Logistics strategy
Logistics has to do with the flow of services into and out of the credit function. Three trends
are evident: centralization, outsourcing and the use of the Internet. The credit function must
decide how it will obtain its inputs, and how it will deliver its services to its customers.
5.4.1.7
Human resource strategy
Human resource strategy addresses the issue of whether the credit department should hire
large numbers of low skilled employees for repetitive jobs with low pay, but may quit after a
short time or hire skilled employees who receive relatively high pay and are cross-trained to
participate in self-managing work teams.
The credit manager must also decide how the staff will be trained ─ internal or external, and
how the staff will be motivated.
5.4.1.8
Information systems strategy
Credit departments are increasingly turning to information system strategies to provide them
with a competitive advantage. The use of EDI, e-mail and other technological arrangements
could enable the credit department to maintain close contact with customers and efficient
control over collections.
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5.5
POLICIES
Policies define the broad guidelines for implementation of the strategy (Wheelen, 2002:184).
Flowing from the selected strategy, policies provide guidelines for decision making and
actions about credit extension and the collection of debtors. It sets out the procedures for
credit and collection activities in order to obtain departmental objectives.
5.5.1 DETERMINANTS OF TRADE CREDIT POLICY
Pike (1998:19) suggests that the credit policy should be shaped by market-based factors and
company specific factors.
5.5.1.1 Market based factors
i)
Competitive position
When a business develops a credit policy, it needs to understand its competitive position.
Credit can help the business to position itself most effectively in the market.
ii)
Industry credit terms
Smaller businesses may find it difficult to move away from normal credit terms within the
specific industry. Where the credit service offered is superior to the competitors’, there is
generally more scope to move away from the industry-wide terms.
iii)
Customer base
An analysis of the customer base can assist credit policy formulation. This may involve
examination of the customer profile (e.g. importance and risk), the trading relationship,
frequency of purchase and customer retention rate. The credit policy should highlight credit
57
procedures for major, high-risk customers and their weighting in relation to the total customer
base.
iv)
Finance available
Management should calculate the financial requirements to fund the credit operation and
determine the most appropriate sources of financing available. This could be done through
internal sources such as retained profit or additional supplier credit. Availability of sources
will depend on the state of the financial markets and the business’s ability to access these
markets.
5.5.1.2
Credit Function Environment
After examining the market environment, the credit manager can now concentrate on the
business’s internal environment. The credit policy should flow from the following: corporate
and departmental mission, goals and strategies, size and structure of the credit department
function, level of information technology competence, credit service characteristics (longer
credit may be sensible where the collateral value of the asset is high, because in the event of
default, the seller may be able to reclaim and resell the asset), and credit sales process (the
length of the selling channel and the size of the sales force will influence the credit screening
and collection process).
Management must also determine a balance between sales and finance when developing an
appropriate credit policy. A financial orientation suggests that the focus will be on risk
minimization, asset protection and tight control in credit granting. A marketing focus will
tend to give greater weight to sales and may be prepared to live with higher default and
delinquency risks.
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5.5.2 POLICY FUNDAMENTALS
The way in which the credit and collection policy is formulated has a direct influence on the
attainment of objectives. The following main components are fundamental in the credit and
collection policy.
5.5.2.1
Credit screening (vetting)
Information regarding customer credit worthiness is available from various sources such as
Kredit Inform, Experian and Credit Information Association.
The credit policy should
provide clear guidance on where, when, what and how much information is required.
The credit department should set a minimum acceptable credit standard for all new and
existing customers. This will enable the business to control credit risks, debtors falling below
the minimum threshold being rejected from further credit extension. The following seven C’s
of credit can be used when evaluating the overall credit quality: character (the buyer’s
integrity and willingness to pay as agreed), capacity (ability to pay), capital (financial
strength), collateral (pledge assets as security), conditions (circumstances or conditions),
credit history (management of past accounts), and common sense ( “gut feeling”).
These factors provide a framework for developing credit standards and investigations.
5.5.2.2
Conditions of sale
A well-designed credit policy should include standardized conditions of sale, credit terms,
methods of payment, security required and risk protection methods (e.g. retention of title
clause) and a right to charge interest on overdue amounts.
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5.5.2.3
Credit terms
Credit terms indicate the credit period for open accounts and discounts for prompt payment.
Credit terms that are frequently quoted, include:
cash before delivery (CBD), cash on
delivery (COD), invoice terms, consignment sales with/without self-billing, periodic
statement and seasonal dating
Industry credit terms and the terms offered by major competitors have a considerable
influence on the credit terms set and help to explain much of the variation in credit periods
among firms. Regardless of the normal credit terms offered, specific credit terms should
always be agreed by the sales and credit functions based upon the merits of each case such as
the estimated default and delinquency risk, product margins and repeat sales prospects.
Granting over-generous credit terms to selected customers can wipe out profit margins
although, too often, the accounting system will not highlight this. This again emphasizes the
need to have a good idea of the profitability of customers before setting credit terms. If a
business can afford to offer better credit terms than its competitors, credit can be viewed as a
strategic investment in building up customer loyalty.
Credit terms and the due date should be printed clearly on the face of the invoices to remind
customers of the credit agreement and to avoid possible future disputes of the “we never
agreed that” variety.
Prompt-payment cash discounts and rebates may be established to expedite receipt of cash, to
stimulate sales or to conform to industry norms. Their effectiveness as a collection tool
depends upon the effective annual percent rate (APR) offered. Prompt-payment discounts
make sense to both buyer and seller when the effective rate exceeds the rate at which the
customer is able to borrow, yet is lower than the seller’s cost of capital. However, where such
60
discounts are also likely to reduce default and delinquency risks, the seller may choose to
offer more favorable incentives. Implications of customers taking unearned discounts and the
cost of rectifying this could be considered when formulating the cash discount policy. A costbenefit analysis of a cash discount proposal, based upon the effective APR approach or the
Net present value (NPV) approach should be performed to avoid making uneconomical
decisions.
5.5.2.4
Credit risk reduction and credit insurance
The risk of bad debts can be reduced and transferred to a third party by means of purchasing
credit insurance, for example to Credit Guarantee Insurance Corporation (CGIC). However,
the insurance premium is only warranted if the risk level is high enough. As there are various
insurance services available in the market that have flexible terms and conditions that suits
different industries and companies, the credit policy should provide guidance on when, what
and how to use the various options.
5.5.2.5
Risk categories and credit limits (Credit line)
An effective credit system should have sufficient categories to allow an adequate and
distinctive grading of risk. According to Pike, (1998:41) no more than five, but fewer than
three with subdivisions should be used. Effective credit management can be encouraged by
facilitating control and follow-up procedures, including credit terms and maximum credit
limits.
Credit limits should be assigned to all customers. These limits can be fixed initially at the
amount the business is prepared to have outstanding from time to time. These limits should
also be reviewed regularly to ensure that they remain applicable. Rules of thumb methods to
establish credit limits should not be used, as it could inhibit business or become a cause of
conflict between the credit and sales functions.
61
Accepting a high-risk customer could enhance the sale of slow moving stock. Therefore, the
credit manager should become involved in sales and marketing issues so that all significant
opportunities may be adequately evaluated to benefit the business as a whole. Regular
meetings with sales management are a way to promote confidence and strengthen the
relationship between sales and credit functions.
5.5.2.6
Monitoring the policy
Credit policy should be monitored on a regular basis to ensure that it is adapted to changing
market requirements. It should be compared with industry, budgets and historical trends to
identify deviations. Monitoring occurs at three levels (Pike, 1998:44).
Compare individual customers against target, management performance against policy and
targets, overall corporate performance against targets, and performance of competitors and the
industry.
5.5.2.7
Collection of Accounts
The collection of debt is a sensitive area in business, which effects the relationship between
the business and its customers.
The collection policy should provide guidance on the
achievement of the right balance between firm control of its customers and sensitivity to
customer’s needs. In particular it should outline the following processes (Pike, 1998:45): the
control and reporting mechanisms, responsibilities for authorizing adjustments, credit returns,
write off of bad debts, items of dispute, and exceptions to normal policy and information
requirements for collection performance reports.
The authors further suggest that the collection policy should be reviewed regularly to ensure
its appropriateness and effectiveness. When the collection policy is changed, the credit
62
manager must carefully evaluate the impact in terms of customer reaction, influence on sales
and income, changing of collection period, and change in bad debt expenses.
5.5.2.8
Credit Standard
The credit standard is the minimum requirements an applicant must meet to qualify for credit.
It indicates which methods and sources of information are used and it gives an indication of
the credit risk that the enterprise is willing to accept.
5.5.2.9
Invoice discounting
Loans can be arranged with specialist finance houses called “invoice discounters”.
A
business can realize invoices immediately in cash up to about 75% of the face value of the
invoices by placing those invoices as collateral security in return for a Bill of Exchange. The
loan must be redeemed at the maturity date. The cost involves an interest charge on the
amount advanced plus a service charge, this charge depending upon the risks and
administration costs involved. Invoice discounts can impose rule and procedures, such as
compulsory credit insurance, before invoices can qualify for advancement.
5.6
SUMMARY
According to the third step in Wheelen’s model, strategy formulation is the development of
long-range plans for the effective management of environmental opportunities and threats, in
light of corporate strengths and weaknesses. It includes defining the corporate mission,
specifying achievable objectives, developing grand strategies and setting policy guidelines.
The credit department as an important function of the organisation also needs to formulate
functional strategies (as oppose to grand strategies) and is therefore also suggested as the third
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step of the proposed framework. However, the focus is on middle managers developing
medium-term, functional strategies specific for the credit function.
In developing the credit function’s mission, the mission of the company must direct credit
manager’s thoughts.
The credit function’s objectives are linked to the organisational objectives and are set by
credit managers since they know exactly what is happening in and around the division.
Functional strategy is developed to achieve credit function objectives and strategies (linked to
organisational objectives) by maximizing resource productivity within the credit function.
The aim is to develop and nurture a distinctive competence to provide the company with a
competitive advantage.
Functional policy, which is derived from organisational policy, provides specific guidelines
for middle (credit) management decision-making that links the formulation of credit function
strategy with its implementation.
The third step of the proposed framework therefore also focuses on the development of
medium-term mission statement, objectives, strategies and policies but by middle-managers.
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CHAPTER 6
STRATEGY IMPLEMENTATION
6.1
INTRODUCTION
According to Wheelen’s model strategy implementation is the process by which strategies and
policies are put into action through the development of programs, budgets and procedures for
the organisation (2002:192). Programs are necessary to state top management activities or
steps needed to accomplish a single-use plan. Top management budget to list the detailed
cost of these programs. Procedures are necessary to describe in detail how particular tasks or
jobs in the entire company should be done.
Implementation of strategies on credit function level is the combination of middle
management plans, choices and activities required to ensure the execution of the strategic
plan. In order to do that, credit managers should develop programs to state activities to be
executed by credit personnel. They also need to budget for the department and techniques
that describe in detail how particular credit and collection tasks should be done should be
developed.
The proposed framework therefore also defines the third step as strategy implementation
through the development of programs, budgets and procedures specifically for the credit
function in order to implement corporate strategy.
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6.2
WHO IMPLEMENTS STRATEGY?
Everybody in the organisation is responsible for the implementation of the strategic plan. Top
management makes the corporate strategy available to middle management.
Middle
management and subordinates put together functional objectives and strategies to support the
corporation’s strategy. Middle management and subordinates put together plans for their
specific units or departments. Therefore, every manager down to every supervisor and every
employee is involved in one way or another in the implementation of strategies.
To ensure that everyone in the organisation is aware of the new direction that the organisation
and credit department is taking, the new mission, goals, strategies and policies must be clearly
communicated down to the lowest levels of the organisation. Further to make sure that the
implementation of the new direction will be a success, staff from all organisational levels
should be involved in formulation and implementation of the strategy.
6.3
PROGRAMS, BUDGETS AND PROCEDURES
The credit manager works with his team to develop programs, budgets and procedures for the
implementation of strategy. He also works to achieve synergy among other functional areas
(e.g. marketing, sales) in order to establish and maintain the company’s distinctive
competence.
6.3.1 PROGRAMS
Departmental programs are the key, routine activities that must be undertaken in the credit
department to provide the credit service. In a sense, it translates thought into action designed
to accomplish specific short-term objectives.
66
Every value chain activity in the credit
department executes departmental tactics that support the business’s strategy and helps
accomplish strategic objectives.
Involving managers and supervisors in the development of functional tactics improves their
understanding of what must be done that will contribute to implementation. The next section
will highlight typical questions that the departmental tactics should answer.
Credit Service Operations Programs: How centralized should the credit service be? How
integrated should the separate processes be? To what extent should further automation be
pursued? How many sources do we need? What is the key focus for control efforts?
Marketing Programs: Which service contributes the most to profitability? What debtor needs
does the service seek to meet? What changes should be influencing our customer orientation?
Can we offer discounts?
Finance Programs: What is an acceptable cost of debt? What risk is appropriate? What
limits, payment terms, and collection procedures are necessary? What payment timing and
procedure should be followed? How liberal/conservative should the credit policy be?
R & D Programs: What critical processes need R&D attention? What new methods are
necessary to shorten DSO?
Human Resource Programs: What key human resources are needed to support the chosen
strategy? How do we recruit these human resources? What are the future human resource
needs? How can we help to develop our credit staff? How can we motivate and retain good
people?
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6.3.2 BUDGETS
Budget is the “costing” of the programs that have been developed. The budget is a “check” to
determine if the strategy will be viable and not too costly. An ideal strategy might be found
to be completely impractical only after specific implementation programs and activities are
costed in detail. It is a plan that allocates resources, co-ordinate operations of the department,
controls the appropriation of funds, and enables managerial control of the department’s
performance.
6.3.2.1
Types of budgets
There are three budgets that are used by organisations. These three budgets, called the pro
forma statutory statements, constitute the final step of the budgetary process. The three types
are as follows:
Income statement - The credit department budget enables the empowerment of managers who
will be responsible for the authorization of expenditure and the responsibility for raising
income. It makes managers responsible for decisions and the consequences of their decisions.
Capital budget - The capital budget is used for the acquisition of items that are used in the
credit function for periods longer than one year. Examples of items of such expenditure are
computers used by credit management staff, office equipment, and machinery.
Cash-flow budget - The cash-flow budget is used to state and monitor the actual cash flow of
the department. It ties in with the other two budgets and focuses on the actual cash flow,
which is the lifeblood of the organisation.
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6.3.3 PROCEDURES
Procedures are a system of sequential steps or techniques that describe in detail how a
particular task or job in the credit functions is to be done. It describes for example in detail
the various credit investigation-, credit granting-, and collection- procedures to be followed.
These procedures must be updated regularly to reflect changes in the strategy.
6.3.3.1
Investigating Procedure
Credit investigation is a series of steps undertaken to verify information provided in an
application for credit. It determines how the customer has handled past financial obligations
as an aid in making a sound credit decision. Credit managers must weigh the value of
additional information about a credit prospect against the cost of obtaining such information.
Information sources that are accurate, complete, speedy and reasonably priced include credit
applicants themselves, direct investigation, in-file ledgers, credit reporting agencies, banks
and other miscellaneous sources (Cole, 1998:179)
6.3.3.2
Analysing Information Procedure
Credit departments make use of credit information to make proper credit decisions. The
analysis of credit information can be done in a number of ways such as: Credit grading where
a grading form is used to evaluate the applicant on a scale rant ranges from excellent to poor.
Credit scoring, where points are allocated to various characteristics or factors. The total score
is compared with the minimum score required to make a decision. Financial statements are
analyzed to determine the organisation’s financial position.
In terms of consumer credit, the so-called C’s of credit help the credit manager complete a
quick mental check to ensure that all relevant applicant information has been included. The
five C’s of credit are: capital, collateral, conditions, credit history and common sense.
69
In terms of trade- or financial credit, the following factors are taken into account to determine
the quality of the credit risk: Integrity of the business and its management, the business risk,
profit or income potential, security it can offer, financial statements, competition and cost of
credit.
6.3.3.3
Decision-making Procedure
Credit assessment leads to credit decisions such as to accept, reject or postpone the
application.
Reasons for poor credit decisions can be either insufficient- or misleading
information or the improper interpretation of the facts.
Should the application be successful, a decision has to be made on the credit limit, or the
maximum amount that the credit department will grant. Credit limits eliminate continuous
decision-making and enables the credit manager to delegate. It protects the department
against excessive bad debts.
6.3.3.4
Collection Procedures
The success of credit sales is determined by how effectively debtors and overdue amounts are
collected. There are three phases in the collection procedure, namely: Reminder phase by
sending the debtor a second statement as a reminder about the outstanding amount. Followup phase by phoning or follow-up letters when the reminder phase did not produce any
results. The reasons are determined why debtors do not pay. Drastic phase where the account
could be handed over to a collection agency or an attorney.
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6.4
STAFFING
The implementation of new credit management strategies and policies often calls for new
human resource management priorities and a different use of credit personnel. Such staffing
issues can involve hiring new people with new skills, firing people with inappropriate or
substandard skills and/or training existing employees to learn new skills.
One way to implement the credit department’s strategy is through training and development.
Selection and development are important not only ensure that people with the right mix of
skills and experiences are initially hired, but also to help them grow on the job so that they
might be prepared for future promotions.
Succession is the process of replacing key personnel. It is especially important for a credit
department that usually promotes from within to prepare its current staff for promotion.
The credit department can identify and prepare its people for important positions in several
ways. One approach is to establish a sound performance appraisal system to identify good
performers with promotion potential. The department should examine its human resource
system to ensure not only that people are being hired without regard to their racial, ethnic or
religious background but also that they are being identified for training and promotion in the
same manner.
Large credit departments could make use of assessment centres to evaluate a person’s
suitability for an advanced credit position. These centres use special interviews, management
games, inbasket exercises, leaderless group discussions, cases analyses and decision-making
exercises to assess the potential of employees for specific positions.
71
Job rotation where people are from one job to another could also be used to ensure that credit
employees are gaining the appropriate mix of experiences to prepare them for future
responsibilities.
6.5
LEADING
Implementation also involves leading employees to use their abilities and skills effectively to
achieve departmental objectives. Without the appropriate leadership, people tend to work
according to their own personal views of how, in what order and where work must be done.
They may approach their work as they have in the past or emphasize only those tasks that they
most enjoy ─ regardless of the credit department’s priorities. This can create real problems,
particularly if the organisation is operating internationally and must adjust to customs and
traditions in other countries. This direction may take the form of management leadership,
communicated norms of behaviour from the departmental culture or agreements among
workers in autonomous work groups (Wheelen, 2002:225). It may also be accomplished
more formally trough action planning or through programs such as Management By
Objectives and Total Quality Management.
6.5.1 MANAGING CULTURE
Culture is the set of important assumptions that members of the credit department share in
common. It includes beliefs and values that influence the way people do their work in the
department.
Because the department’s culture can have a powerful influence on the
behaviour of employees, it can strongly affect the credit function’ s ability to shift its strategic
direction. A problem for a strong culture is that a change in mission, objectives, strategies or
policies is not likely to be successful if it is in opposition to the accepted culture of the credit
72
department. Departmental culture has a strong tendency to resist change because its very
reason for existence often rests on preserving stable relationships and patterns of behaviour.
6.5.1.1
Assessing strategy-culture compatibility
An optimal culture is the culture that supports the vision, mission and strategy of the credit
department. Like structure and staffing, culture should also support the strategy. If the
culture is not in agreement of the new strategy, the department’s culture needs to be changed.
Culture can be changed, but it takes a long time. It is therefore necessary for an organisation
and the credit function in particular, to assess the strategy-culture compatibility.
According to Pearce (2003:215), asking the following questions can assess the strategyculture compatibility:
Is the planned strategy compatible with the department’s current culture? If the answer is yes,
the credit function can proceed with its new strategy. Can the culture be easily modified to
make it more compatible with the new strategy? If the answer is yes, carefully change the
culture by training and developing the current staff members or as an alternative, employ
appropriate staff who will be able to effect the necessary change. Is the credit function
willing and able to make major changes and accept possible delays and possible increase in
costs? If the answer is yes, manage around the culture by establishing a new structural unit to
implement the new strategy. Is management still committed to implementing the strategy? If
the answer is yes, find a joint-venture partner or contract with another organisation to
implement the strategy.
If the answer is no to the questions discussed above, the department should consider changing
the strategy.
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6.5.1.2
Manage culture through communication.
Cultural change can also be managed through communication. Communication is imperative
for the successful management of change.
Management should communicate changes
through speeches and newsletters to staff. Training and development programs should also be
used.
The following can be done:
the credit function vision should be clear and be
communicated to all employees at all levels of the credit department. The vision should be
concretised into key elements that are necessary to achieve the vision. If for example the
department states that superior customer service is part of its vision, appropriate measures
should be developed to measure the success the department is achieving in realising its vision.
6.5.2
ACTION PLANNING
Activities can be directed toward achieving strategic goals through action planning. An
action plan states what actions are going to be taken, by whom, during what timeframe, and
with what expected results.
After activities have been determined to implement a particular strategy, an action plan should
be developed to put these activities in place. The resulting action plan should include much of
the following information: specific actions to be taken to make the program operational, dates
to begin and end each action, person (identified by name and title) responsible for carrying
out each action, person responsible for monitoring the timeliness and effectiveness of each
action, expected financial and physical consequences of each action, and contingency plans.
74
6.5.3 MANAGEMENT BY OBJECTIVES (MBO)
Management by objectives (MBO) is an approach to help ensure purposeful action toward
desired credit function objectives.
It links departmental objectives and the behavior of
individuals.
The MBO process involves (Wheelen, 2002:220):
formalising and communicating
departmental goals and objectives, setting individual objectives (through manager-subordinate
interaction) that help implement departmental objectives, developing action plans of activities
to achieve the objectives, reviewing performance periodically and include the results in the
performance appraisal of the staff member.
MBO is an appropriate way to cascade the goals of the department to the lowest levels of the
department. It ensures that all the efforts of the staff are co-ordinated and unified to the
accomplishment of the common goal of the organisation.
One of the real advantages of MBO is that it can reduce the amount of internal politics
operating within a large department. Political actions within a department can cause conflict
and create divisions between the very people and groups who should be working together to
implement strategy. People are les likely to jockey for position if the department’s mission
and objectives are clear and they know that the reward systems is based on achieving clearly
communicated, measurable objectives.
6.5.4 TOTAL QUALITY MANAGEMENT
Total Quality Management (TQM) is an operational philosophy committed to customer
satisfaction and continuous improvement (Wheelen, 2002:232). TQM is committed to being
75
the best in all functions and has four objectives: better, less variable quality of the credit
service, quicker, less variable response in processes to customer needs, greater flexibility in
adjusting to customer’s changing needs, and lower cost through quality improvement and
elimination of non-value adding work.
According to TQM, faulty credit function procedures and processes, not poorly motivated
employees, is the cause of defects in quality service. The program involves a significant
change in credit department culture, requiring strong leadership from the credit manager,
employee training, empowerment of the lower level employees and teamwork for it to
succeed. It focuses on prevention, not correction. Inspection for quality credit service still
takes place, but the focus is on improving all the credit processes and procedures to prevent
errors and deficiencies. Thus, a quality circle or quality improvement team can be formed to
identify problems and come up with suggestions to improve these processes.
TQM’s important ingredients are:
An intense focus on customer satisfaction. Everyone understands that their jobs exist only
because of customer needs. Thus all jobs must be evaluated in terms of how it will affect
customer satisfaction.
Internal and external customers. An employee in the credit approval department may be the
internal customer of another employee who collects the money, just as the debtor is a
customer of the credit function. An employee must be just as concerned with pleasing the
internal customer as in satisfying the external customer.
76
Accurate measurement of every critical variable in the credit function’s operations. This
means that employees should be trained in what to measure, how to measure it, and how to
interpret the data. A rule of TQM is that you can only improve what you can measure.
Continuous improvement of credit services. Operations need to be continuously monitored to
find ways to improve credit services.
Work relationships based on trust and teamwork.
Empowerment is important – giving
employees wide latitude in how they go about in achieving the department’s objectives. The
key to TQM success lies in executive commitment, an open departmental culture and
employee empowerment.
6.6
SUMMARY
Wheelen’s model defines strategy implementation as the third step to manage an organisation
strategically. It is a process by which corporate strategies and policies are put into action
through the development of programs, budgets and procedures.
The proposed model also defines strategy implementation as the third step to manage the
credit function strategically. However, programs that support corporate programs state credit
function activities needed to accomplish credit management objectives.
Credit managers also need to budget for the credit function to list the detail cost of each of
these programs.
Credit and collection procedures should be developed to describe specific techniques in detail
of how credit function tasks and jobs are to be done.
77
CHAPTER 7
STRATEGY EVALUATION AND CONTROL
7.1
INTRODUCTION
Wheelen’s model list (2002:16) evaluation and control as the fourth step on how to manage an
organisation strategically. He defines it as the process in which corporate activities and
performance results are monitored so that actual performance can be compared with desired
performance. Managers at all levels use the resulting information to take corrective action
and resolve problems.
Performance, the end result of activities, includes the actual outcomes of the strategic
management process. The practice of strategic management is justified in terms of its ability
to improve an organisation’s performance, typically measured in terms of profits and return
on investment.
Operational control systems at credit function level is equally important to guide, monitor and
evaluate progress in meeting short-term objectives.
The practice of strategic credit
management is justified in terms of its ability to improve the credit department’s performance
(which contribute to organisational performance), typically measured in terms of how soon
debtors can be converted into cash and the cost of granting credit. For evaluation and control
of the credit function, credit managers must obtain clear, prompt and unbiased information
from the people below them. Using this information, credit managers compare what is
actually happening with what was originally planned in the formulation phase.
78
While strategic control attempts to steer the company over an extended period (usually five
years of more), credit management (operational) control provides post action evaluation and
control over short periods ─ usually from one month to one year.
To be effective, operational control systems must take four steps, namely set standards of
performance, measure actual performance, identify deviations from standards set and initiate
corrective action.
The proposed framework’s fourth step will therefore also be defined as evaluation and control
in managing the credit function strategically and completes the strategic credit management
framework. Based on performance results, credit managers may need to make adjustments in
its strategy formulation and/or implementation.
7.2
PERFORMANCE MEASURES
Performance is the end result (outcomes) of credit management activities. Which measures to
select to assess performance depends on the credit function to be appraised and the objectives
to be achieved.
The credit function may use a variety of techniques to evaluate and control performance. The
Balanced Scorecard approach, devised by Kaplan and Norton, and Benchmarking are two of
the many performance measurement systems that help credit managers to clarify and
communicate its goals and translate strategy into performance measures and targets.
79
7.2.1 BALANCED SCORECARD
The balanced scorecard combines financial measures with other measures in such a way that a
balanced view of the credit function is achieved.
It provides a balanced approach by
developing performance measures from four different perspectives of the credit function. The
credit manager should measure the set objectives in each of the following four areas as
depicted in Figure 7.1:
financial perspective, customer perspective, internal process
perspective and innovation/improving perspective.
FIGURE 7.1: CREDIT MANAGEMENT PERSPECTIVES
Financial perspective
Total cost of debtors
Return on
receivables
Bad debts
Credit Sales
% Collection
Number of new
accounts
Acceptance index
Past due index
Age analysis
Questionable
Customer perspective
Customer
satisfaction index
Defection rate
Repeat business
New customers
On-time delivery
Internal process
Invoicing quickly
Customer contact
Credit granting
Performance
related pay
Innovation and learning
% customers using
EDI, direct debts, etc.
Accuracy of scoring
methods and collection
forecasting
Source: Adapted from Pike, 1998:69
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7.2.1.1
Financial Performance Measures
It is important for the business to monitor the cost of granting credit, otherwise it would not
know whether the credit function is cost-effective and whether parts of it could be more
economically outsourced.
Many measures can be used to evaluate the success of the credit management process such as
total cost of debtors, bad-debt loss, credit sales, collection days, number of new accounts,
acceptance index, past due, age analyses, questionable accounts, inactive accounts, monthly
expenses.
i)
Total cost of receivables = Credit and collection costs + Bad debt losses + cost of
carrying debtors.
Apart from bad debt expenses, other explicit costs that should also be taken into account are
salaries and wages of credit staff, other operating costs of the credit function, lost interest as
result of late payments, credit agency- and legal costs and cost of financing the credit offered.
This refers to the net credit position – the excess of the average value of debtors over
creditors. Should interest charges rise, it may result in a rise in both accounts receivable and
accounts payable. Debtors monitoring should therefore not be conducted in isolation but as
part of total balance sheet management. One of the hidden costs in credit management is the
potential loss in revenue due to over-stringent credit control.
The total cost of credit extension and return on receivables can also be calculated for each risk
class. This information can then be used for monitoring, benchmarking and decision-making.
ii)
Return on receivables = Operating profit after cost of capital charge divided by
average accounts receivable
81
Table 7.1 illustrates how debtor days, total cost and return on receivables can be calculated for
accounts and main risk classes. (Pike, 1998:71): The higher risk customers in class C
represent 23 per cent of sales, but 36 per cent of debtors. The cost analysis shows this
category to have a much higher than average total cost/sales percentage (12.1 per cent
compared with 6.7 per cent) and a much lower than average return on receivables ratio (0,38
compared with 1.0).
TABLE 7.1: DEBTORS DAYS, TOTAL COST OF CREDIT AND RETURN ON
ACCOUNTS RECEIVABLE
DEBTOR DAYS
Risk class or
division
A
B
C
Annual Sales
(Rm)
38,4
54,0
27,6
120,0
% of total
sales (%)
32
45
23
100
Average
Debtors (Rm)
3.6
6,5
5,8
15,9
% of total
debtors (%)
23
41
36
100
Debtors Days
34
43
75
152
TOTAL COST OF CREDIT
Allocation of credit costs:
Annual sales (R’000)
All accounts
120 000
A
38400
B
54 000
C
27 600
CREDIT & COLLECTION
COSTS
Variable: (R’000)
% of annual sales
Fixed : (R’000)
% of annual sales
Bad debts: (R’000)
% of annual sales
Average debtors (R’000)
Cost of capital @ 10%
(R’000)
Total cost of credit
Total cost/sales (%)
Total cost/debtors (%)
-
2 190
810
0
1.825
1 152
3 600
1 620
3
3
-
660
8 040
3
0
3600
360
82
0.2
6500
2
5800
580
3 340
3,9
42
3
552
650
1 152
6,7
50,6
5
828
108
0.055
15,900
1 590
1 380
1,5
3 340
5,9
49
12,1
57,6
RETURN ON ACCOUNTS RECEIVABLE
Annual sales
Average debtors (X)
Operating profit before credit
(given)
Credit and collection cost
Variable
Fixed
Bad debts
Operating profit after credit
costs
Cost of capital:
@ 10 % of debtors
Profit after cost of capital (Y)
Return on receivables (Y/X)
All accounts
R’000
120 000
15 900
A
R’000
38 400
3 600
B
R’000
54 000
6 500
C
R’000
27 600
5 800
24 000
7 680
10 800
5 520
2 190
3 600
660
6 450
1 152
1 152
810
1 620
108
2 538
1 380
828
552
2 760
17 550
6 528
8 262
2 760
1 590
15 960
360
6 168
650
7 612
580
2 180
1,0
1,71
1,17
0,38
Source, Adapted from Pike, 1998:71.
iii)
Bad-debt loss
Bad-debt loss divided by Total credit sales
The efficient operation of the credit function can, for example, be judged by the manager’s
ability to reduce bad-debt losses to a minimum.
It is important that bad debts are not carried too long as it could give a misleading variation in
the bad-debt ratio as result of the “lag” factor. For example, when credit sales are increasing,
while cash sales are staying more or less the same, the base on which the index is calculated
will increase and appear more favourable. Percentages of bad-debt losses can vary depending
on different lines of business, the month or season of the year, and general business
conditions.
The credit manager therefore should compare the current year’s ratio with
previous years and also with similar businesses.
iv)
Credit sales index = Credit sales divided by Total net sales
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It is important that the business knows what percentage of total sales is represented by credit
transactions. This percentage or index is computed by dividing credit sales by total net sales:
Businesses that deal with consumer credit should determine the percentage of business done
on each type of credit (e.g. instalment credit, charge account, etc.) If the credit manager
compares these indexes from month to month or over a period of years, the business gets a
valuable picture of its credit business and some effects of its credit policy. If the business
compares the index with other businesses operating under similar conditions, they will have
an indication of the success achieved in obtaining credit business.
In commercial credit, operations are a classification of accounts by risk categories. For
example, the following type of breakdown can be carried out within the broader framework of
an industry or product-line classification of accounts:
prime – large, well established
businesses involving no real credit risk, good – Businesses that can be expected to discount
but lack the stature of prime accounts, limited – businesses that are suspect enough to be held
within a definite credit line, and marginal – high-risk accounts that bear constant watching.
v)
Collection percentage, days to collect, and turnover of receivables.
The following tests are discussed under one heading because they are simply different ways
of stating a similar fundamental relationship. One of the most commonly used credit control
indexes, the collection percentage, is determined by dividing the total amounts collected
during a period (month) by total receivables outstanding at the beginning of the period.
Collection index = Collections made during period divided by Receivables outstanding
at beginning of period
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The average collection period is derived from the collection index, and estimates the average
length of time that receivables are outstanding. If, for example the net credit period for your
business is 30 days, and the collection index is 50 per cent, indicating that only half of the
outstanding receivables were collected during the month, receivables would “on average” be
60 days outstanding.
Average collection period = Net credit period divided by Collection index
Another criterion of credit management efficiency is how it uses capital invested in accounts
receivables. The rate of receivables turnover is computed by dividing the total sales by the
average receivables outstanding, as follows:
Receivables turnover rate = Total credit sales divided by Average receivables outstanding
The seasonality of the business is important in determining how to compute the average of the
receivables outstanding, for example:
Number of days to collect credit accounts = 360 days is the receivables turnover rate
The advantage of these measures over the bad-debt loss calculation is that, because they can
be calculated earlier, they help forecast difficulties in collection far enough in advance for the
business to take corrective action. Decreasing collection percentages show an accumulation
of poor accounts or a slackening of collection efforts before the bad conditions become
inevitable. These measures of credit activity should enable credit management to detect the
effects of unsound policies, for example: a falling collection percentage indicates unduly
85
lenient terms, solicitation of unsound classes of customers, and a yielding to competitive
temptations to outdo others in credit.
On the other hand, unduly stringent collection activity, overly conservative credit acceptance,
and undue hesitation in taking risks can by detected earlier by studying the trend of collection
percentages.
As with the previous indexes, these figures should be compared with previous months and
with those for the same month of as many preceding years as possible. This comparative
information can give the credit function an idea of the seasonal trends that should be
considered in any analysis. Likewise, comparisons with similar firms give some indication of
the subject firm’s relative standing.
Remember though, that these indexes reflect only averages; certain accounts may be falling
behind in payments at the same time that overall collection tests disclose a favourable picture.
Credit personnel should recognise this situation and allow for it in any analysis based on
averages.
Improvement in a business’s collection percentage may reflect improved economic conditions
even before an increase in credit and cash sales. This situation may arise because customers
tend to repay previously incurred debts before assuming new ones. On the other hand, a
decline in economic conditions is more likely to be reflected earlier in declining credit sales
than in declining collection percentages. This results form the debtor’s reluctance to make
additional credit purchases until they are sure they can pay for them.
vi)
Number of New Accounts
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This figure shows the extent to which the enterprise emphasis credit service and whether or
not it is wide awake to opportunities for attracting new trade. The number of new accounts
may also be an indication of the effectiveness of the credit publicity. This figure, together
with the next figure, the acceptance percentage, measures the leniency or strictness of the
business’s credit policy.
vii)
Acceptance Index = Applications accepted divided by Applications submitted
The number of acceptances is an indication of the business’s attitude towards applications, the
quality of the applicants, and the credit policy currently being forwarded. A measure of
growing importance is the index or percentage that shows the proportion of applicants for
credit that are accepted.
This index can vary considerably, depending on the business’s line of business, the leniency
or strictness of its credit-granting policies, and the stage of the business cycle.
viii)
Past-due index = Total past due divided by Total outstanding
This measurement indicates the proportion of all past-due accounts, in amount or number.
With this we mean that this ratio should be figured in both number and Rand because
computing both formulas could give a very different picture if one large account is severely
past due versus several small accounts past due. It is computed by dividing the total past due
by the total outstanding as follows:
When the credit function computes this index for a couple of successive periods, it serves as a
barometer indicating whether the general trend of poor pay is up or down. If, for example,
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this percentage increases faster than it should at any given time, credit management can take
steps to hold back the trend or bring it back to its normal position.
ix)
Age Analysis
Just to refresh your memory, the age analysis of debtors, in its simplest form, is a general
survey of accounts with the emphasis on accounts in arrears. In a more extensive form the
analysis can include a history of payments (the last date of payment) and a credit rating code
as well as any other information considered necessary.
The accounts included in the age analysis will indicate amounts in arrears at a glance. The
status of a specific account or even a group of accounts can quickly be determined with this
analysis. The information contained in the age analysis can be grouped further by singling
out all accounts in a specific age group. All accounts more than 90 days in arrears can, for
example, be classified in one group in order to receive special attention. (The collecting
procedure changes as the age of the outstanding account increases).
This age analysis can be made in various ways – depending largely on the preferences and the
needs of the individual business.
It is possible to refine the age analysis of individual
outstanding accounts – in accordance with the needs of its users. Table 7.2 is a further
example of how an age analysis may be made. Written reports on the position of debtors in
arrears may be based on an analysis of these tables.
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TABLE 7.2: AGE ANAYLSIS OF DEBTORS IN ARREARS
Age analysis of debtors in arrears
Age analysis of outstanding debtors
Account
Number
256980
Total amount
outstanding
R 15 000
30-60 days
58723
R 18 000
R10 000
975431
R 20 000
984632
R 7 000
60-90 days
R 15 000
90+ days
R 8 000
R 20 000
R 5 000
R 2 000
Collecting step
Response
2nd account
2 letters
telephone
2nd account
2 letters
2nd account
3 letters
telephone
2nd account
3 letters
telephone
Promise
No response
No response
Promise
No response
No response
Age analysis of debtors in arrears
Age analysis of outstanding debtors
Account
Number
Total amount
outstanding
30-60 days
60-90 days
256980
R 15 000
R 15 000
58723
R 18 000
975431
R 20 000
984632
R 7 000
x)
R10 000
90+ days
R 8 000
R 20 000
R 5 000
R 2 000
Last date of
payment and
amount
Comments
15/02/2004
R 35 000
5/05/2004
R 10 000
15/02/2004
R 5 000
Slow
Payer
First late
Payment
Payment
received after
third letter
Irregular
payment
3/04/2004
Questionable Accounts
This is a report on all outstanding accounts that are probably not collectable. Information in
this report is used as a starting point in determining reserves for bad debts. The business
therefore provides for possible bad debt.
It also reveals information on the accounts
concerned – including the history of the account, collection steps already taken and the
amount that will probably be written off as uncollectable. Businesses that sell on credit and
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consequently have debtors, provide for a reserve for bad debts. Should an account therefore
be written off as uncollectable, it is done against this reserve.
xi)
Inactive Accounts
This is a report on all accounts that have been inactive for a considerable time. Information in
this report is used to send a letter to each account holder who has not bought on credit for
three months or longer. In this letter, the customer is invited to make purchases from the
business. Special discounts are offered if the account holder were to buy on credit from the
business. Through this, the business also tries to establish whether the specific reasons why
the customer is no longer using his credit facilities. An example is where the customer might
be dissatisfied with the service he receives or where he might not like the product ranges sold
by the business.
xii)
Monthly Expenses
All expenses incurred by the credit and collection division in a particular month are analysed
in this report. Information in this report is used to prepare the budget for this division.
Furthermore, the analysis serves as a control measure to ensure that the credit and collection
division remains within the limits of the budget. If any deviations occur, the credit manager
must stipulate in the report what the contributing causes were and what corrective action is
planned. For example, in the budget the business provided for telephone expenses of R25 000
per month. The actual expenses for June 2004 amounted to R40 000. Why is there such a
large deviation?
The credit division must investigate the matter and determine the
contributing causes.
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TABLE 7.3: MONTHLY EXPENSES
COST OF ANALYSIS OF THE CREDIT AND COLLECTION DIVISION
DATE: 30 JUNE 2005
Activity
Budget
Actual
30/6/2005
Cost as % of sales
2004
2005
Salaries
Stationery
Telephone
Electricity
Transport
Credit reports
Collection costs: agencies
Administrative costs
General
TOTAL
7.2.1.2
Customer Performance Measures
According to Pike, (1998:74), there is a correlation between customer satisfaction and
payments made by debtors. By focusing on satisfying customers and managing key accounts,
a company can improve its average collection period, which ultimately improves profitability.
Pike’s research suggests that customers are more profitable to the supplier the longer the
trading relationship continues. It is not until after the initial marketing and set-up costs have
been recovered that customers begin to make money for the business. As the relationship
develops, satisfied customers increase the level and rate of repeat orders, become less
preoccupied with price, and frequently introduce other customers. It is not uncommon for a
business to lose over 20 per cent of its customers each year, which therefore necessitates
considerable time and cost in attracting and developing new customers who make take some
years before they make the same contribution as those who defected.
The credit function can be so preoccupied with managing accounts receivable that it fails to
realize how significant a part it can play in retaining profitable customers and enhancing
customer loyalty.
Regular contacts with customers through visits and telephone
conversations, rapid resolution of queries and a sensitive approach to payment delay can go a
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long way to improving customer loyalty. Performance measures to which the credit function
contributes would therefore include a customer satisfaction index, defection rates, level of
repeat business, number of new customers, query resolution rate, and company visits.
The financial health of customers is very important. While a company cannot influence the
financial health of its customers, it can improve the level of customer satisfaction and the
quality of its trading relationship
To better understand how a firm can become its customers’ most valued supplier it need look
how it trades as a customer with its suppliers. The credit management and purchasing
functions should regularly meet to understand each other’s perspective and compare policies.
The most important factors in selecting suppliers are the quality of their credit control, good
sales representatives, favourable credit terms, higher discount, on-time delivery and lower
prices.
7.2.1.3
Internal Process Performance Measures
Meeting financial and other goals demands that credit function processes, decisions and
actions are effective and co-ordinated throughout the department. Chapters four and five have
discussed the credit management policies and practices deemed to be consistent with “best
practice”. It is for each credit function to identify which of these processes it needs to excel at
in order to meet both customer and financial goals. These processes could include the speed
of invoicing, the speed of resolving customer’s queries and the correctness of monthly
statements.
Many credit functions operate some form of performance-related pay to stimulate motivation
and efficiency. Senior management and sales representatives regularly receive bonuses based
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upon sales or profits. A transaction is not complete until the cash is received. Incentives
based upon cash flow will therefore reflect slow or non-payment of debts.
Objectives are reviewed monthly on an individual and divisional basis.
Each target is
weighted and used to calculate performance scores in determining annual bonuses. The credit
manager must develop measures that can evaluate the efficiency of its crucial processes.
7.2.1.4
Innovation and Learning Performance Measures
To be globally competitive, large businesses must continually strive to improve its service
offerings to its customers. The credit function, which forms an important part of the value
chain of a business, should also continually strive to improve its service offerings to the
business’s customers.
According to Pike, (1998:79), the following are examples of a credit manager’s performance
measures: percentage of customers using the internet and direct debits or customers changing
to the internet and direct debits, classification accuracy rates for monthly cash collection and
reliability of credit scoring methods,
7.2.2 BENCHMARKING
Benchmarking is the continual process of measuring credit services and practices against the
toughest competitors or those companies recognised as credit industry leaders (Wheelen,
2002:254).
Benchmarking is based on the concept that it makes no sense to reinvent
something that someone else is already using. It involves learning how other credit functions
work and then apply it or try to improve on it. The benchmarking process usually involves
the following steps: (1) Determine the area or process to be examined – it should be an
activity or process that determines the credit department’s competitive advantage, or it must
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have the potential therefore. (2) Obtain measurements – if the activity or process is important
for the credit function, there should be a measure. (3) Select best practice credit functions –
not only organisations that are in the same line of business but who are in different industries
but have similar activities. (4) Determine the differences and why the differences exist. (5)
Develop tactical plans to close performance gaps. (6) Implement the plans and compare
again.
Benchmarking is the appropriate technique to compare an organisation’s processes with the
best practises in the industry to ensure that credit services are delivered the most effective
way.
7.3
GUIDELINES FOR PROPER CONTROL
In designing a control system, the credit manager should remember that controls should
follow strategy. Controls should ensure the use of the proper strategy to achieve objectives
otherwise the achievement of objectives will not be a success. The following guidelines, as
adapted from Wheelen (2002:259) could be followed:
•
Minimum amount of information should be used for control purposes. The credit
department should focus only on the critical success factors: those 20% of the factors
that determine 80% of the results. These factors will give a reliable picture of the
performance of the credit function. Too many controls will create confusion.
•
Meaningful activities and results should be monitored for control purposes. Even if it is
difficult to measure an activity, an objective or subjective measure must be found to
measure the performance.
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•
Controls should be timely. If information of deviations is revealed too late, corrective
action cannot be taken. The credit function can use the balanced scorecard to control its
activities and performance. This technique will help to produce timely information
•
Long-term and short-term controls should be used.
It is likely that short-term
managerial orientation will ensue if only short-term measures are used. A balanced
portfolio of measures should be used.
•
Controls should be focused on exceptions.
Only those results that fall outside a
predetermined range should be reported and explained.
•
Emphasise the reward of meeting or exceeding standards. The reaching or exceeding of
standards should be connected to the performance evaluation of the department’s staff.
If punishment results from the inability to reach standards, it could lead to lobbying for
lower standards or even fiddling with the measurements.
A strong, appropriate culture will lead to a smaller need for an extensive formal control
system.
7.4
SUMMARY
Wheelen’s model fourth and final defines evaluation and control as the process in which
corporate activities and performance results are monitored so that actual performance can be
compared with desired performance. Managers at all levels use the resulting information to
take corrective action and resolve problems.
Organisational performance includes the actual outcomes of the strategic management
process. The practice of strategic management is justified in terms of its ability to improve an
organisation’s performance, typically measured in terms of profits and return on investment.
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The proposed strategic credit management framework adopted this step as the final step in the
framework since credit management activities and performance results also need to be
monitored to compare real performance with desired performance.
However, credit management (operational) control systems identify the performance
standards associated with allocation and use of the function’s financial, physical and human
resources in pursuit of its strategy, which will contribute to organisational success.
The proposed framework suggests the balanced scorecard method and benchmarking as two
techniques to evaluate and control credit function’s performance.
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CHAPTER 8
RESULTS, CONCLUSION AND RECOMMENDATIONS
8.1
RESULTS
Organizational strategy is concerned with creating and maintaining a competitive advantage
in each and every area of business. It can be achieved through any one function, although it is
likely to be achieved through a unique and distinctive combination of functional activities.
For each functional area of the business, such as production, human resources and credit the
company will have a functional strategy to be managed strategically (Thompson, 1997:17). It
is important that functional strategies are designed and managed in a co-ordinated way so that
they interrelate with each other and at the same time collectively allow the organizational
strategy to be implemented properly.
One of the questions that was usually asked during discussions with many credit executives
was how they view the contribution of strategic credit management to the success of their
organisations.
It was concluded that credit management is still regarded in many
organisations as solely the collecting of overdue debts, often by junior staff without the
authority to negotiate problem cases. Although the importance of receivables management, as
one of the biggest assets on a business's balance sheet is undisputed, many companies do not
consider it to be part of their core activities.
Because business is usually concerned with the sale of goods or services op open account at
profit, the credit function plays an important pivotal role within the organisation.
It
contributes to the common primary objective of the organisation by maximizing profit and is
therefore good business practice to put credit management at the front end.
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The attainment of an appropriate match between an organisation's strategy and its credit
function strategy has positive effects on the organisation's performance. This match or link
should be done in a skilful manner by tapping on the expertise of top management as well as
credit executives.
Despite the availability of many models on how to manage an organisation strategically, there
is a lack of guidelines on how to link the credit function's strategy to that of the organisation.
The solution lies in the development of a framework that will link these two strategies. To
design and manage the credit function strategy in a co-ordinated way so that it interrelates
with other functional strategies and are aligned with the organizational strategy, this
framework should be build up of those elements necessary to manage an organisation
strategically. However, this framework should be adapted in such a manner to be more
functional orientated and applicable specifically in the credit function.
8.2
CONCLUSION
To achieve corporate objectives and strategies, the credit function must adopt a strategic
approach to maximize resource productivity. This approach should be concerned with the
development and nurturing of a distinctive competence to provide the company with a
competitive advantage. Literature findings of this study highlighted the need for systematic
and comprehensive research in the area of strategic credit management.
To develop this distinctive competence, it is imperative that every company does have a
framework on how to link the strategy of the credit function with the organisation's long-term
strategy. The strategic credit management framework proposed by this study should develop
in the credit manager a general, strategic management point of view, which will force them to
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explicitly think about the credit function as a complex system within a total environment.
This strategic point of view is useful to any credit professional who needs to sharpen his
awareness and understanding of this individual contribution to the total enterprise. This
proposed framework of strategic credit management will enable the credit manager to see how
a credit function can become a master, rather than a captive, of the unique circumstances it
faces - deliberately pursuing objectives and formulating strategies, rather than being shaped
by luck and external forces.
8.3
RECOMMENDATIONS
In order to be successful, credit functions must be strategically aware. They must understand
how changes in their competitive environment are unfolding. The implied proactivity and
reactivity require strong and appropriate resources which continue to ensure that the credit
function is able to meet the needs and expectations of the company’s debtor clients.
Satisfying the changing needs of customers in a dynamic environment demands flexibility and
sound control measures. Credit employees should be empowered to make and carry out
decisions. But, to be strategically effective, this must be within a clear and co-ordinated
directed framework. This is not a reality in practice which inspired the author to develop such
a framework.
However, the applicability of this framework, as developed and proposed by this study, needs
to be implemented and tested in future research. The author should then have the opportunity
to convert operational credit activities into a more refined strategic credit management model.
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By providing and training credit managers with this proposed framework as guideline on how
to use this framework effectively will allow for the organizational competitive strategy to be
implemented properly.
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