Portfolio Management

How to Better Know Your Customers

As a credit manager, a critical part of your role is to identify who you can trust and to what extent you find their claims realistic. This is translated into knowing your customers well and defining whether they can pay you as agreed. Naturally, you may not have much information for new clients. The amount of credit awarded requires careful consideration when managing new and existing customers. Luckily, there is a method for evaluating how creditworthy they can be.

 

Knowing your customer starts with a general credit application. This important document introduces applicants to you and includes all of the required essentials: the applicant’s legal name, address, owner, contact information, and preferred way of communicating. You may also want to know who their banker is, plus 3 to 4 main suppliers for trade references. Credit applications should be short and basic as further knowledge will be acquired throughout the relationship with the client. Keep the essentials mentioned above. A signed credit application should give you permission to check credit history, obligate the customer to pay your invoices, plus any late fees or interest charges incurred. While it is a good starting point, it may not be all the information you need to make an informed decision.

 

Now you need to evaluate risk vs. reward. Usually, the more reward there is, the more risk the business needs to take (in the form of credit). However, companies will have multiple lines of business units that have different perceptions of risk tolerance. As discussed before, the credit team has to figure out the right amount of risk that can be taken, meaning how much bad debt they can live with. The challenge is to take calculated risks by analyzing the available information. The more information you have, the better your decision-making will be.

 

To get an understanding of the risk and the reward, you need to access two sources of information: sales (the reward) and the customer’s ability to pay (the risk). What are the projected sales or volume, and how much does the Sales Department believe they will make (margin)? These measures provide an idea of how much credit is needed by comparing the projected volume to the proposed payments terms. The margin provides you with the reward, and the application allows you to evaluate the risk with all necessary data.

 

No matter how automated the credit/collections/accounts receivable process is, you still have to make a decision about this client. When evaluating potential customers, start with your own Credit Policy. This will give you an idea of how deep to dive before sitting down with the client and your Sales Department.

 

Finally, don’t just crunch the numbers: review statements, bank reports, trade history, and gain insight into a customer’s financial capacity. Raise concerns and get firsthand answers. Always consider how they have paid in the past before making a decision for increasing their existing credit limit. Basically, have reasonable expectations based on reasonable criteria. If you are uncertain, don’t hesitate to contact the Credit Institute of Canada who can happily refer you to a Certified Credit Professional (CCP) in your area.

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Published under: Portfolio Management
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