According to Merriam-Webster, credit is defined as the “the provision of money, goods, or services with the expectation of future payment.” Trade credit, also known as purchase credit, allows customers to receive goods whose value is charged against an account to which the buyer will pay in cash at a date in the future. This form of short-term finance is utilized by business to business companies to better manage their working capital.
Trade credit is originated, processed, and executed in a variety of methods across industries. Based on legal requirements, industry standards/best practices, number of customers, line of business, etc., businesses require different information and documentation in order to gauge creditworthiness. Some industries rely heavily on credit bureau reports, while others rely more on credit references and financial statements. Despite the differences in approach, the credit approval process comes down to four basic steps no matter the industry.
These four steps are:
- Credit Request
- Information/Data Collection
- Credit Decision
We call these four steps the Universal Credit Process (UCP).
The first step in the Universal Credit Process is Credit Request. The credit request comes in the form of a prospective customer applying for initial credit terms or from an existing customer asking for an increased credit limit. Initial requests typically come in the form of submission of a credit application. Existing customer requests typically come in the normal course of business as customers exceed their credit limit.
The second step is Information/Data Collection. Data collection involves gathering the information needed to make an informed credit decision based on the riskiness of the customer’s credit profile and business. Examples of data gathered includes:
- Legal Name & Address
- Business Information (size, years in business, etc)
- Trade/Bank Reference Contacts
- Financial Statements
- Credit Bureau Reports
- Personal Guarantees
- Tax Exempt Certificates
- Licenses (Driver’s, Contractor’s, etc)
- Internal Business/Credit Experience with the Customer
Traditionally this step is filled with manual, paper-based processes such as scanning, printing, and filing. Difficulties in gathering sufficient and correct data represent a significant bottleneck in the credit approval process.
The third step is Analysis. Once sufficient data is gathered it is analyzed to gauge the customer’s capacity and willingness to pay. Metrics used include:
- Average High/Low Credit
- Average High/Low Balance over the last 12 months
- Highest Past Due
- Days Late
- Credit Bureau Metrics
- Financial Performance Ratios
Many credit managers utilize their own custom scorecard models to standardize the analysis process and give an objective measure of creditworthiness. Procedures in this step can be risk segmented with different requirements for different levels of credit desired or other forms of customer segmentation.
The final step is Decision. At this step, the credit manager considers all the data that has been gathered and analyzed to form an objective opinion on the customer’s capacity and willingness to meet its credit obligations. Based on this view the customer is either approved and given a specific credit limit and terms, or they are denied credit.
No matter the industry, the Universal Credit Process is a useful tool to develop credit management procedures and to examine where bottlenecks occur in your credit management processes.