Credit Risk Forum

Credit is always a hot issue. However, the "credit education" promoted by the government in recent years has little effect on the construction of credit system in China. When tracking down the reason behind this, we find that moral exhortation is not the key to solve credit-related problems while the establishment of macro mechanisms and self-construction of micro entities may be more feasible. Firstly, credit information collection and spread mechanisms at macro level should be established to increase the cost of companies for dishonesty and also increase the incentives for companies to keep faith. As economic entities at micro level, the companies should gain more awareness on credit risk prevention and control, get a grip on necessary credit risk knowledge and build an internal credit management system to improve their own credit management.

In a general sense, the credit management function can be further divided into client information management, client credit assessment & credit policy formulation, accounts receivable management, receivables collection and creditors management. In the following context we take a close look at the entities to fulfill each of the above functions or, in other words, where the credit department should stand in corporate organizational structure and how to integrate such functions into current management process of the company.

Selection of credit management organization

Basically, there are four credit management organization patterns adopted internationally, which are sales department-dominant credit management, finance department-dominant credit management, separate credit department and risk committee system. Every pattern has there advantages, disadvantages and applicable conditions.

The sales department-dominant credit management is applicable to the companies with management competencies and high-calibre sales staff so that the initiatives of sales department can be brought into full play. Sales department enjoys an edge in respect of human resource and information resource as well as direct and favorable customer relationship, but this does not necessarily assure the fulfillment of credit risk management function due to the deficiencies of sales department in credit analysis and credit management.

The finance department-dominant credit management is applicable to the companies setting store by the role and influence of finance department, which is expected to keep in check the risk incurred by sales department, and holds advantage in the specialization and expertise of credit analysis and credit management. However, with frequent dissents from sales department and customer service department, the finance department usually finds it is difficult to make full use of the customer relationship for better credit management.

Separate credit management department is applicable to the companies with vague ideas on credit management and where sales department prevails over finance department both in terms of role and influence. Thanks to its relatively independent stance, the credit management department can have more freedom in formulating and implementing policies as regards credit information management, human resource management and relevant incentive and restrictive measures, but tough resistance might be inevitable in early operations of the credit management department.

Risk committee system is usually applicable to financial organizations or ultra-sized companies whose informatization level is very high. Credit management will then be considered from a corporate strategy perspective, and the high level of specialization can ensure the effectiveness of credit risk management, but complicated process, high cost and supervision difficulty are amongst the disadvantages of this pattern.

It thus can be seen that the selection of credit management pattern should follow the principle of suiting actual circumstances. However, two key factors cannot be neglected whatever the pattern is. Firstly, indicators must be designed to curb the risk arising from sales department and this means that receivables collection is equally important as sales. Secondly, rigid reporting process, which involves credit management policy, standard operating procedure, form tools and reporting system, must be set down to make every step traceable and accountable. All these are actually safeguards on the fulfillment of credit management function.

Credit control points

Almost all daily duties of credit risk management department can find their counterparts in the links of sales process.

Just like sales process, credit management process is a continuous and complete chain consisting of numerous links and every link is corresponding to a credit risk control point although different companies might make different priority list of these credit control points in light of the actual market condition and transaction pattern, which can be explained by following examples:

A Company pursues its line of business in petrochemical industry where credit sales are common practice, profit margin is narrow and the risk stemming from certain clients is very high since every single transaction can be of huge amount. For A Company, the occurrence of bad debts will be fatal, which makes the screening and selection of client a key control point. The countermeasure we prescribe is that the company should build a reasonable client credit rating model and rank all its clients by the level of risk, ensuring credit sales to each of them controlled with strictness commensurate to their risk and each of them kept under dynamic monitoring.

B Company pursues its line of business in engineering machinery manufacturing industry and adopts channels sales. The value of every transaction is big and profit margin is broad, but most of its distributors and dealers are financially weak, which makes the design and formulation of credit policies a key control point in credit management process. The company can consider a multivariate combination of credit policies that prove to be effective in speeding up collection under such circumstances.

C Company pursues its line of business in fast moving consumer goods industry whose clients are mostly large shopping malls and supermarkets and every single transaction between them is of modest amount, but their transactions can be very frequent and involve a good assortment of commodities. Due to its weak negotiation position, C Company has to often suffer the payment delays of its clients with every possible excuse or even their deliberate performance default, which usually results in credit losses finally. In this case, the key control point is accounts receivable tracking and collection before the accounts become uncollectible.

The routines of credit management should be an integral chain uninterruptedly from link to link and the missing of any link means underlying risk to the company. Whichever industry you are in, process control should always be a foundation for your credit management as long as credit transaction exists, and deserves its due attention from management officers and decision makers.

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The intensified competition in a growing economy necessitates credit sales in a wide range of industries, but due to asymmetric credit information and inadequate credit risk management, the companies always show much prudence or even hesitation when granting credit on open account. It is critically important for a company to acquire complete information on credit standing of any client considered for a credit decision, or in plain terms, whether the client has the money and good will to pay. Anything that can shed a light on these two aspects is called client credit information, to name a few, financial position, sales performance, shareholder background, market reputation and internal management of the client.

It is worth noting that some companies use financial statements as the only reference to rate the credit of a client, but the reality is that, in today's China, the financial statements are not so solid a reference as they are supposed to be, which make it necessary for the companies to attach more importance on the collection and digging of other relevant data. Usually, the internal information can be valuable to assess a client's credit standing, such as sales records & contracts from the sales department and payment records & payment vouchers from finance department. However, these departments always refuse to volunteer their information on the ground of confidentiality or understaffing.

Credit investigation agency, with specialization and expertise in this area accumulated from operations on a large scale, can provide standard and complete data in a prompt manner, and the companies can make a cross reference of outsourced credit report with internal data to reach a sound conclusion.

To make better and informed credit decision with all data available plays a key role in credit management.

To be scientific with a credit rating model

Credit rating model can be seen as a ruler to measure every client by the risk that they may bring to the company, but how does this ruler work is always problematic. Impulsive decision makings and useless regrets after the mistake has been done are not rare in the business world, and what's more it is usually impossible to conciliate the divergent views of every department. The company alone is not enough to give an overwhelmingly authoritative and reliable credit remark that can convince all. Thus, to hire a professional credit rating firm or research institute to help the company build a scientific credit rating model will be a better choice.

To be discriminative with a policy

To explain credit policy in short, it would be "how much I would allow you to owe me and for how long"? The company should be discriminative with differential and convincing credit policies, which means firstly that you have to category all clients and create different credit policies for every of them. When designing the credit policies, you must take into consideration not only the credit score of this client, but also your own financial capacity, market competitiveness and payment practice generally adopted industry wide.

To be watchful with a risk alarm system

The companies should identify and keep track of various risk signals and build risk alarm system with all credit data collected. For example, any overexpansion or management reshuffle of the client should be documented and ranked from high to low in terms of risk level with corresponding countermeasures set out.

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