What is Credit Management?
Credit management is all about overviewing and supervising the loaning process so that the risk associated with loaning funds to borrowers can be minimized. It entails granting credit, setting the terms of the agreement, recovering the credit amount, conducting due diligence, etc.
An effective credit management process focuses on minimizing the credit risk that could adversely impact the cash flow and lead to losses. An effective credit management process helps to minimize the capital amount tied up with debtors so that it can be invested to gain returns.
A good credit management policy ensures that the business never faces any cash flow disruptions. Eliminating bad debts by reducing the credit risk can help a great deal when it comes to saving funds for profitable ventures. Banking and financial institutions play a great role when it comes to channelling funds into the economy.
Naturally, the chances of credit risk increase when an organization is in the business of loaning out funds. An effective credit management policy is a necessity for players in the banking and financial services industry.
Objectives of Credit Management
Your primary objective in credit management should be the avoidance of excessive debt. Easy access to credit including multiple credit accounts with large credit lines can lead to severe financial problems and even bankruptcy in the event of a job loss or illness. You should follow conservative spending guidelines for determining how large your overall credit lines should be relative to your income--and how much debt you should carry on those lines.
Credit risk management is also one of the most prestigious careers in the finance industry. One can opt for a credit management course to obtain a comprehensive understanding of the process and have an edge over the competition. Now that we have a fair idea of what Credit Management entails, let's delve deeper into the objectives of credit management.
Lenders design lending pricing, policies and procedures for employees to achieve credit-risk objectives. Based on borrower credit scores, procedures advise bank employees on how to process and price loan applications to reduce credit risks. Banks often instruct lending staff to approve or reject applicants based on their credit scores.
For example, lender procedures may permit loan officers to approve loans at higher than market interest rates for borrowers with credit problems that increase loan risk.
Managing Financial Risk
The most important objective of credit management is reducing financial risk for banks and businesses. Loaning out funds is an important function for banks and also for other financial institutions that are primarily working on providing credits for all small and big businesses. Credit risk is attached to the process of loaning out funds. Credit risk is the risk of default by the borrower on their loan repayment obligation. There are a lot of factors that can increase the credit risk which may result in a huge loss for banks and financial corporations.
Credit management helps to effectively manage the financial risk associated with doing business. Effective credit management policies help to weed out the bad borrowers who do not qualify for a loan from banks. When companies follow the credit management policies put in place, they can deal better with losses and bad debts. They are more prepared to handle the risk of default by the borrowers because they loaned out funds in their risk capacity.
Improving Cash Flow
The second most important objective of credit management in the list is related to improving the cash flow. Cash flow is related to the cash income and expenditure that are recorded in the company's books of account. Keeping a balanced cash flow helps businesses to manage their investments effectively. Businesses need to have cash for various purposes; it could be for paying a creditor or a supplier, purchasing assets or inventory, investing, etc.
Businesses can lose out on profitable investment opportunities due to a lack of cash at a given time. Maintaining a balanced cash flow helps businesses to operate freely and increase their overall income by investing in profitable projects. It also helps them maintain a healthy business relationship with its suppliers and creditors.
Increased credit risk can hamper the cash flow and lead to losses. Improving cash flow can make or break the game for organizations, especially for banks and financial companies.
Other than improving cash flow and managing financial risk, this objective is also equally important if not more. Fiduciary responsibility refers to the legal and moral obligation that a company has to act in the best interest of its clients or other stakeholders.
The lending companies also have a fiduciary responsibility towards their shareholders which makes them accountable for all of their actions. Conservative credit risk management policy is important to maintaining fiduciary responsibility as it helps to safeguard the loan portfolios and reduces the probability of bad debts that could harm the interest of the shareholders.