Many businesses provide credit to customers for the goods or services they offer. To mitigate their credit risk and ensure timely repayment, they implement credit control strategies to assign them a credit limit based on their repayment capacity and risk profile. Therefore, it is an effective method to prevent bad debt and manage credit risk by protecting against consumer defaults and late payments. Understanding the credit control meaning and methods can help an organisation develop a sound strategy to maximise their sales and improve financial health with minimal risk involved.
Keep reading to know all about what is credit control, its types, and methods for efficient credit management.
What is Credit Control?
Credit-related businesses use credit control strategies to ensure timely repayment and manage credit risk for customers who finance goods or services with credit. The procedure involves implementing various procedures and policies to set limits, evaluate creditworthiness, monitor repayments, and control outstanding receivables.
The process begins with a checking credit score, based on which the credit providers evaluate a potential borrower’s creditworthiness. They check their credit score online and review their credit history, financial statements, and repayment habits to determine their credit behaviour. The primary goal is to ensure timely repayment and avoid bad debt. Effective methods of credit control require a solid system to manage credit, including policies, tools, and procedures for monitoring and controlling credit.
How Does Credit Control Work?
Many companies provide credit to their customers, making it easier for them to purchase the products or services while distributing their costs in EMIs. Since the customers no longer need to pay the product’s cost upfront, the purchase becomes easier for them. However, the product’s cost increases because these companies also charge interest on the credit. Credit control involves implementing strategies to protect a credit-providing business from high-risk borrowers.
Allowing customers to purchase the products or services with credit potentially increases sales. Moreover, the company eventually receives the money with added interest. However, the company can benefit only if the customers pay the cost of their purchase on time. Setting credit limits, performing credit checks, regular monitoring, etc., are effective methods of credit control.
Different Types of Credit Control
After understanding what credit control means, learning about its different types is crucial. They are of two types:
1. Quantitative control to regulate credit flow
2. Qualitative control to regulate total credit volume
Key measures for quantitative control include the following:
- Bank Rate Policy: The Bank rate is the official interest rate the company sets to rediscount approved bills. The rate fluctuates according to the country's money supply and inflation conditions, as set by the RBI.
- Open Market Operations: A company can control credit volume by conducting direct sales and purchasing bills and securities.
- Cash Reserve Ratio (CRR): It sets the portion of the total deposit a company must maintain as a cash reserve.
- Statutory Liquidity Ratio (SLR): It sets the portion of deposits a company must maintain with itself in the form of liquid assets.
A company implements qualitative control methods of credit control for selective objectives like:
- Credit Policy: The company sets specific credit limits for customers based on their creditworthiness and repayment history.
- Risk Assessment: The company evaluates potential borrowers' financial stability and industry outlook to minimise default risks.
- Terms and Conditions: Clear and structured credit terms are established, including repayment schedules and penalties for late payments.
- Customer Evaluation: The company assesses customers' behaviour, financial health, and relationship with the business to determine their creditworthiness.
Importance of Credit Control
Credit control is essential when it comes to maintaining the cash flow of a credit-providing company. For instance, if the credit company lends a loan to a borrower with a poor credit score, chances are higher that the borrower will delay or miss the EMI payments, leading to the credit provider’s loss. If the borrower continues such behaviour on a wider scale and defaults on the loan, the loan provider will develop inadequate liquidity and find it challenging to carry out regular operations.
The need for credit control arises when lenders want to ensure they provide credit to customers with good credit histories only, improving their chances of receiving prompt repayments. As a result, the finance company will maintain enough liquidity and cash flow to stay operational.
The Essential Steps of a Credit Control Process
While implementing the credit control process, be sure to cover these essential steps:
- Collecting accurate customer information, including their name, address, contact details, etc.
- Conducting due diligence and check credit score online for new clients to evaluate their reputation, payment history, finances, and business.
- Setting credit limits to manage the risk exposure.
- Holding frequent reviews to check overdue and pending bills, following up with customers with dues, and resolving disputes over the outstanding invoice.
- Negotiating repayment plans to make repayment easier for the customers.
Conclusion
Credit control is integral to the consumer lending network that helps companies manage their cash flow and regular operations. It attracts more customers and increases company sales while attracting additional interest. Therefore, companies extending credit to customers must implement a robust credit regulation system to provide easy credit to credible customers without putting their money at risk.
Frequently Asked Questions
1. What are the four methods of credit control?
Setting credit limits, checking credit scores, regularly monitoring repayments, and negotiating feasible repayment plans are the four best methods of credit control.
2. What is an example of credit control?
Suppose Manoj is an electronics store owner who extends loans to its customers to purchase the products he sells. Although a credit facility will increase sales and attract more customers, he must implement credit control strategies to minimise credit risk. These include checking the customers' credit ratings, setting credit limits, and monitoring their timely repayment.
3. Why is credit management & control important?
Credit management and control are extremely important for organisations extending credit to customers. It helps them avoid lending to customers with inconsistent repayment habits, poor credit history, and irresponsible credit behaviour. Lending loans helps a company increase sales, but it can sustain the business only if they get their repayments on time. Adopting methods of credit control avoid such circumstances and ensure timely repayment.
4. What is the credit control area?
The credit control area is a unit that controls and manages customer credit limits. It uses various parameters, like risk category, payment terms and credit limits, to define it. The area is linked to a code the company can use to manage credit limits across various sales regions and areas.
5. Where can the ECN number be found on a CIBIL report?
The ECN number is typically located in the top right corner of the CIBIL credit report.
