What Is Credit Control?
Credit control, also called credit policy, includes the strategies employed by businesses to accelerate sales of products or services through the extension of credit to potential customers or clients. At its most basic level, businesses prefer to extend credit to those with “good” credit and limit credit to those with “weak” credit, or possibly even a history of delinquency. Credit control might also be called credit management, depending on the scenario under review.
- Credit control is a business strategy that promotes the selling of goods or services by extending credit to customers.
- Most businesses try to extend credit to customers with a good credit history so as to ensure payment of the goods or services.
- Companies draft credit control policies that are either restrictive, moderate, or liberal.
- Credit control focuses on the following areas: credit period, cash discounts, credit standards, and collection policy.
Understanding Credit Control
A business's success or failure primarily depends on the demand for products or services. As a rule of thumb, higher sales lead to bigger profits, which in turn leads to higher stock prices. Sales, a clear metric in generating business success, in turn, depends on several factors. Some, like the health of the economy, are exogenous, or out of the company’s control, other factors are under a company’s control. These major controllable factors include sales prices, product quality, advertising, and the firm’s control of credit through its credit policy.
In general, credit control seeks to extend credit to a customer to make it easier for them to purchase a good or service. This strategy delays payment for the customer, making the purchase more attractive, or it breaks the purchase price into installments, also making it easier for a customer to justify the purchase, though interest charges will increase the overall cost.
The benefit for the business is increased sales which leads to increased profits. The important aspect of a credit control policy, however, is determining who to extend credit to. Extending credit to individuals with a poor credit history can result in not being paid for the good or service sold. Depending on the business and the amount of bad credit extended, this can adversely impact a business in a serious way. Businesses must determine what kind of credit control policy they are willing and able to implement.
Credit Control Policies
A company can decide on the type of policy it wishes to implement when drafting its credit control policy. The options typically include three levels: restrictive, moderate, and liberal. A restrictive policy is a low-risk strategy, limiting credit only to customers with a strong credit history, a moderate policy is a middle-of-the-road risk strategy that takes on more risk, while a liberal credit control policy is a high-risk strategy where the company extends credit to most customers.
Businesses that aim to gain higher levels of market share or that have high-profit margins are typically comfortable with liberal credit control policies. This also applies to companies that have a monopoly in their industry so that they can hold onto the monopoly. That said, if the monopoly is firmly rooted, the firm may be inclined to adopt a restrictive policy, given the low threat of entrants to the market. A firm in this enviable position does not need to worry much about upsetting its customer base.
Credit Control Factors
Credit policy or credit control primarily focus on the four following factors:
- Credit period: Which is the length of time a customer has to pay
- Cash discounts: Some businesses offer a percentage reduction of discount from the sales price if the purchaser pays in cash before the end of the discount period. Cash discounts present purchasers an incentive to pay in cash more quickly.
- Credit standards: Includes the required financial strength a customer must possess to qualify for credit. Lower credit standards boost sales but also increase bad debts. Many consumer credit applications use a FICO score as a barometer of creditworthiness.
- Collection policy: Measures the aggressiveness in attempting to collect slow or late paying accounts. A tougher policy may speed up collections, but could also anger a customer and drive them to take their business to a competitor.
A credit manager or credit committee for certain businesses are usually responsible for administering credit policies. Often accounting, finance, operations, and sales managers come together to balance the above credit controls, in hopes of stimulating business with sales on credit, but without hurting future results with the need for bad debt write-offs.