Wed, Oct 26, 2022

Credit and Collections Defined

When defining credit and collections, it's best to begin with an understanding of accounts receivables, which is money owed to an entity by its customers. Correspondingly, the amount not yet received is credit, and the amount still owed past the due date is collections.

Companies typically sell goods and services on an invoice basis with a future due date, often referred to as the “payment term” or “terms;” thus, dealing with the credit process, and, unfortunately, the collections process, is also common. Bringing credit and collections to a personal level, if a friend owes you money, a personal “IOU” doesn’t usually have credit and collections best practices. Albeit, at times, perhaps they should!

The accounts receivable, credit and collections process covers activities related to accounting for and dealing with money owed to an organization. All activities related to the calculation of amounts due; generation of invoices; posting of receivables to the general ledger (GL); cash receipts; and application to receivables, write-offs, reserves and collections are key to this process. Each step should prompt you to reflect on your company’s current practices, such as:

  • Eliminate barriers to payment.
  • Enhance customer satisfaction.
  • Perform B2B transactions.

As such, the credit and collections process is much more than just getting paid. It involves a credit and collections integration potentially across several divisions and business units and links to systems, technology and people.

For a business, good processes around receivables, credit and collections can be the difference between staying in business and not. With any business practice, there needs to be a well-defined and clearly stated set of business objectives. Monitoring and improving the business credit and collections process to meet those objectives will require appropriate performance measures.

Dissecting the Credit and Collections Process

If you are a business professional, you are aware of the many steps to the credit and collection process. Additionally, you know that they require additional actions beyond merely sending out an invoice and getting paid. There are several leading practices for the accounts receivable, credit and collections process, including the following:

  • Identify and act on distressed and delinquent accounts.
  • Assign and update the customer credit rating.
  • Automate the remittance processing function.
  • Use the credit and collections process to enhance customer satisfaction.
  • Develop, motivate and monitor collections specialists.

A successful business is an organized business. An organization generally starts with a business or process flow — which is a sequential representation of a process and its components. A process flow’s objective is to standardize and optimize your processes and help employees and teams to understand how your business operates. It typically includes operations, timelines, and the human and capital resources needed to carry out the activities. A process flow for the credit and collections activities will include those listed above and any other steps specific to your company or industry.

A Central Hub for Credit and Collections

The following are examples of some of the many credit and collections, tools and training options available from KnowledgeLeader:

  • One example of a resourceful tool is the Credit and Collections Policy. This tool contains two sample policies that outline guidelines and standards for reviewing and understanding an organization’s credit and collections process. This type of policy intends to provide for the credit and collection of accounts receivable in a nondiscriminatory manner while maximizing the company’s profitability by maintaining a moderate level of investment in accounts receivable, minimizing write-offs of bad debt and maximizing sales.
  • An example of a specific tool focused on benchmarking, such as Accounts Receivable, Credit and Collections Leading Practices. Accounts receivable is among the largest and most liquid assets on the books of most companies. Properly managed accounts receivable portfolios can expedite cash flow and support corporate cash requirements. Increasing working capital is the goal of accounts receivable.
  • Another powerful tool is Process Accounts Receivable, Credit and Collections Key Performance Indicators. This benchmarking tool contains key performance measures an organization should consider when processing accounts receivable, credit and collections. An effective business process is built on a set of well-defined and clearly stated business objectives. These key objectives articulate the ideal performance results that the company expects from that process.

To monitor a business process so that it stays focused on reaching the key objectives, the company should choose appropriate performance measures. Careful selection of performance measures takes a company a long way toward improving a business process.

When determining what process improvements are needed to reach the next level of maturity, evaluators should consider the importance of the process being addressed. When the importance level increases, its desired capability increases.

  • KnowledgeLeader’s blog contains updated and targeted information on credit and collections. One example of a recent blog post is a general introduction to the subject, What Is Accounts Receivable, Credit and Collections? In recent blog posts, we’ve discussed KPIs for various processes and even given a concise description of what they are. In this post, we look at KPIs for accounts receivable (AR), credit and collections, and we provide a resourceful document that goes into considerable depth.
  • KnowledgeLeader provides a user-friendly set of checklists and questionnaires to assist a company’s collections, audit and treasury teams. An example of a checklist is the Sarbanes-Oxley Policy Evaluation Checklist, which provides points to consider when conducting an organization’s Sarbanes-Oxley (SOX) policy evaluation.

Checklist items include cash receipts, bank account reconciliations, banking policies and relationships, cash disbursements/manual checks, check signing requirements, outstanding checks, general cash, petty cash, deposits, investment responsibility, foreign currency translation, the fair value of financial instruments, derivatives policy, investments in associated companies, functional currency, hedging guidelines, general accounts receivable, credit memos, allowance for doubtful accounts/credit risk, credit balances, and customer deposits.

  • An example of a questionnaire is the Accounts Receivable, Credit and Collections Questionnaire, which can be used to compare your current business practices with leading practices for the accounts receivable, credit and collections processes.
  • There are guidelines, lists and descriptions of several credit and collections procedures and policies integral to the success of a business. One example is the Accounts Receivable Policy. This tool contains two sample policies that establish procedures to ensure consistency in a company’s accounting treatment of receivables. It includes guidelines focused on how and when to reserve a receivable, write off a receivable, and recover a receivable.

Accounting is responsible for maintaining accurate records within the accounts receivable function and ensuring that proper internal controls are maintained. In these samples, the company’s philosophy of receivable management is predicated on the presumption that the overall credit quality of the company’s customer base is good and the likelihood of bad debts is minimal.

  • Another policy is the Accounts Receivable Policies and Procedures – Credit Holds. This policy outlines procedures for dealing with withholding or delaying an order because of customer non-payment. In addition, this policy deals with withholding or delaying an order due to 1) the perception of a risk condition that leads a company to believe it will not be paid on a timely basis, 2) an account has exceeded or could exceed its approved credit limit, or 3) a delinquency condition on the customer’s account and the existence of invalid or unauthorized deductions. According to this policy, the decision to withhold from immediate release or otherwise delay a customer’s order is critical because of the short lead times for deliveries.
  • An audit report is an appraisal of a small business’s complete financial status. It can also be specific to a division or unit of a business. Regarding credit and collections, we provide the Accounts Receivable Credit and Collections Audit Report. This document contains three sample audit reports that can be used by auditors to learn how other organizations performed an accounts receivable credit and collections audit.

Testing involved activities such as tracking the types of adjustments resulting from billing errors and using this information for training purposes, assessing an existing customer's creditworthiness in the event of additional sales orders, and documenting policies and procedures related to the credit memo and write-off process. The following observations were noted as a result of testing and were integral to the business's redesign of its credit and collections processes.

  • Collection efforts by the branch offices and corporate collections personnel are not always performed in accordance with company policy.
  • Credit policies are not consistently adhered to by sales personnel or consistently enforced by management.
  • Policies on processing and authorizing credit memos and write-offs are not clearly defined.
  • A formal credit scoring system does not exist.

In addition to the above, KnowledgeLeader provides more credit and collections templates, risk and control matrices, surveys, articles, guides, booklets, and opinion pieces from experts in their particular fields. We regularly publish and update a variety of other sample tools, including charters, memos, process flows, job descriptions and key performance indicators (KPIs), for managing risk, conducting internal audits and leading an internal audit department.

Furthermore, KLplus CPE Training includes interactive, self-paced streaming CPE courses that are a rich source of education on a wide range of topics, including internal audit, Sarbanes-Oxley, project management and data analytics.

KnowledgeLeader helps you to reduce your worries about getting paid and allows you to focus your efforts on helping your business thrive. Be proactive rather than reactive with your credit and collections process. Soon after, experience the direct benefits to your business and its bottom line.