Conduct regular staff training in credit procedures. In order to ensure that customer credit-granting issues are dealt with in a reliable and con­sistent manner, the credit staff must receive training for the corporate credit policy and all related procedures. This is an extremely important step, since many of the controls noted in this section are manual ones that require adherence to a standard credit-granting approach in order to be successful.

Arrange for automatic notification of credit rating changes. The initial credit application and review process can give a company a reasonable picture of a customer’s financial situation, but this picture will begin to diverge from the customer’s actual financial situation immediately. Credit monitoring services, such as Dun & Bradstreet, will issue an e-mail notification to the company whenever a targeted customer’s credit rating changes. For this monitoring control to be successful, there should be a procedure in place for updating the company’s list of cus­tomers to be reported on by the third-party rating agency as well as a person designated to follow up on all reported changes.

Require a credit application for orders above a baseline level. The credit application yields detailed information about a customer’s own­ership and finances, and so provides key information regarding how much credit to grant. Accordingly, a good control is to require a credit application from new customers if their order is of a sufficiently large size or if a series of small orders cumulatively exceeds a baseline level.

Require a new credit application if customers have not placed orders re­cently. If a customer has been granted a credit limit but has not placed an order recently, it may be prudent to require the customer to complete a new credit application to reevaluate the size of its credit limit. However, this places a burden on both the customer and the credit depart­ment, so the review typically is restricted to those customers not hav­ing placed orders in a long time and for whom the new order is an especially large one.

• Investigate unanswered questions on the credit application. When a customer does not answer a question on the standard company credit report, this is a potential warning sign that the customer does not want to impart information to the company. A standard control should be to require the credit staff to follow up in detail on all unanswered credit ap­plication questions. This control should be specifically included in the credit application procedure.
• Verify the existence of a new customer. If a customer is a new one, there is a chance that it is a shell company being used for fraudulent deliveries from the company. To guard against this, the computer system should flag all newly created customers for which a new order has just been received. This should trigger an investigation by the credit staff to verify the existence of the new company, usually through a credit report or online inquiry through the state secretary of state’s office.
• Review the credit levels of the top 20 percent of customers each year. The primary risk of incurring a significant bad debt from a customer lies with the top 20 percent of customers by revenue, since they typi­cally account for 80 percent of all corporate revenue. To keep a proper level of control over this subset of customers, it is reasonable to conduct a review of their credit levels each year, including an analysis of pay­ment trends, order volumes, credit reports, and possibly site visits.
• Review the credit levels of all customers issuing NSF checks. If a cus­tomer pays with a check that is returned due to not sufficient funds (NSF), this is a clear indicator of future bad debt trouble and should trigger a control point whereby the customer’s credit is immediately put on hold and its credit limit is subjected to an evaluation.
• Review the credit levels of customers who skip payments. If a customer skips a large payment in favor of paying a smaller amount that is due somewhat later, this can be a deliberate ploy to give the appearance of being approximately current with payments while actually delaying the bulk of payments beyond terms. Consequently, detecting this problem provides an early warning regarding potential bad debt situations. Unfortunately, detecting skipped payments is difficult to automate and is most easily detected by the cash application staff.

• Review the credit levels of customers who stop taking early payment dis­counts. When a customer has a history of taking early payment dis­counts, it is a safe bet that the abrupt termination of those early payments signals a reduction in the customer’s ability to pay. Consequently, a cost-effective control is to create a report listing customers who no longer take early payment discounts, and to include it on the credit de­partment’s schedule of reports to be printed at regular intervals. If a customer appears on the report, there should be a procedure in place to route the report to a credit analyst for further review.
• Generate a report showing the last credit review date. Since a cus­tomer’s financial situation changes regularly, it is useful to conduct follow-up credit reviews to ensure that the current credit level coin­cides with the customer’s ability to pay. Accordingly, the credit re­view procedure should require the credit staff to update the last credit review date field in the customer master file. In addition, the staff should regularly run a report listing the last review date for each cus­tomer, which it should use as the foundation for scheduling additional credit reviews.
• Generate a report showing credit levels exceeded. If a company’s credit-granting systems are working properly, it should be impossible for a customer to be shipped more goods than its credit limit allows. By running a standard report that flags all customers who have exceeded their credit limits, the management team can determine if there are breakdowns in the credit granting process. This is a good detective control.

Everything about the credit department involves the mitigation of risk, so this section listed a great many controls, all targeted at ways to ensure that bad debt losses are minimized. Few of them can be integrated into a computerized system, instead requiring the close integration of numerous manual control points. Given the large volume of controls noted here, you should consider implementing the appropriate minimum mix of controls to ensure that risk levels are reduced to an appropriate level, without seriously increasing the workload of the credit staff.

[tags]credit management, order entry[/tags]

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