The New Credit Paradigm

By Abe WalkingBear Sanchez

In his book The Structure of Scientific Revolutions, first published in 1962, Thomas Kuhn defines a paradigm as an accepted set of givens that provides a model problem and a successful solution that works for that time. As things change, the old paradigm becomes incompatible with the new reality. In time, new knowledge brings about a paradigm shift.

The Old Credit Paradigm
Many business executives are caught up thinking about credit in much the same way as their fathers and grandfathers did in the 1950s. But today's world is very different. The old risk management/accounting thinking must give way to a new understanding if modern companies are to utilize their credit area to its fullest profit potential.

The 1950s were very much defined by the aftermath of World War II. It was a time of pent-up, growing demand for goods and services. Americans had money in the bank or in war bonds. It was a time of great social change worldwide, and a time of limited competition.

In what was a seller's market, with people standing in line to buy things, credit was seen as a privilege, as a favor to some and not others. In such a business environment, the focus was rightly placed on avoiding the risk of customers failing to pay and incurring bad debt losses. The goal was risk management, and metrics like Days Sales Outstanding (DSO), average turn time on accounts receivable and bad debt percentage were appropriate performance measurements.

Credit in Today's World
In 2009, things are very different from the way they were in the 1950s. In order to compete, modern companies must have quality in their products and services, and quality in the way they carry out business functions. A lack of quality will lead to increased costs of doing business for everyone involved in a transaction and, in time, to the failure of a company to turn a profit and survive. Almost across the board, consumer customer-service levels continue to hit all-time lows. Companies—and the next generation of managers—can and will stop buying from a supplier who abuses them or drives up their cost of doing business.

The Profit System of B2B Credit
Explanation of the Profit System of B2B Credit involves discussion of the purpose of credit, the policies associated with extending credit, the people requirements and the necessary performance measurements.

Purpose. The only reason for a business to incur the additional costs that go with extending credit to its customers is to get a profitable sale that would otherwise be lost. If business customers have the ability and willingness to pay up front, extending credit should not be considered. Credit is a lubricant of commerce and allows for the expanded movement of products and services.

Policies. Every business function can be broken down to its major components. Understandable and thereby achievable goals can then be established for each of the major components. Policies are goal-driven guidelines. The major components for the credit function are credit approval, past due accounts receivable management and internal communications.

If credit is extended to get profitable sales that would otherwise be lost, then it follows that the goal of credit approval should be to find a way to say yes to profitable sales while remaining confident of receiving payment.

The vast majority of past due customers are not out to avoid payment. Past due accounts receivable management is not collections or the enforcement of payment. It is the process of completing the sale. The goal of past due accounts receivable management is to keep customers current and buying. The most profitable sales are often repeat sales to the same customers. The credit function interfaces with customers, vendors and many different internal departments. This places the credit function in an ideal position to identify and communicate areas of opportunity for improvement, which, in turn, leads to the constant improvement of how things are done. That leads to controlling the cost of doing business for everyone involved.

People Requirements. First and foremost, the people carrying out the credit function must be able to communicate. Before you ask for a résumé, ask for a ten-minute telephone interview.

Performance Measures. Measure the performance of credit approval based on the percentage of applied-for dollars that are successfully approved, or even exceeded. Measure the performance of past due accounts receivable management based on percentage current to 30 days past due and remember that this is a general guideline. There are always possibilities for profitable exceptions. Measure the performance of internal communications based on the number of improvements identified. Business executives who continue to think of their credit function as a negative, as a cost center, as a necessary evil and/or as the ugly stepchild of accounting do so at their own risk.

The next generation of material handling managers will stop buying from a supplier who abuses them or drives up their cost of doing business.

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The MHEDA Journal • Second Quarter 2009 • Volume 38, No. 2 • Contents are Copyright © Data Key Communications, Inc.
All rights reserved. • Nothing may be reproduced in whole or part without written permission of the publisher.