Critical Business Functions: Misunderstood, Underutilized, and Undervalued Part One: Credit and A/R Management

  • Written By: Charles Chewning Jr. and Abe WalkingBear Sanchez
  • Published: February 2 2005

Critical Business Functions: Misunderstood, Underutilized, and Undervalued Part One: Credit and A/R Management
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"In every age and time there is a turning point, a new way of seeing and asserting the coherence of the world."

Jacob Bronowski, The Ascent of Man

What is the best value proposition for the credit function in business? If we consider the most common key performance indicators (KPI)—Days Sales Outstanding (DSO) and percent of bad debt—it would seem that the major role of credit is risk management. However these measurements and the thinking behind them are flawed, out-of-date, and potentially detrimental in today's business world.

Accounts receivable (A/R) is one of the largest and most liquid of corporate assets, credit and A/R management may be the most misunderstood, underutilized, and undervalued business process. For example, the potential cash flow that can be generated when A/R is brought under control is huge. A very modest three-day reduction in A/R for a typical $20 million company can be in excess of $200,000!

Yet, most often credit and A/R management are thought to be part of accounting—a cost center and a necessary evil. However, because of the potential of credit and A/R management, they should be an integral part of the sales process, by helping establish a framework for a long term and mutually beneficial relationship between buyer and seller. They can play a critical role in the prospect-to-cash cycle.

Credit and A/R Management as a Sales Function

Credit and A/R management is a sales enhancement function whose true potential has yet to be realized by most businesses. Credit is a lubricant of commerce and allows the expanded movement of products and services. Yet, improperly applied, credit policies can hinder free flowing commerce.

There was a time not so very long ago when there were valid reasons for viewing extended credit as a privilege, as a favor to some and not for others. Following World War II, pent up demand, commercial shortages, and earnings from work in the war effort precipitated unprecedented growth. Outside of North America, much of the industrial world had been badly damaged or destroyed by the war and had to be rebuilt. The lack of readily available finances for reconstruction in Europe created even more demand for credit.

Later, the 1950s became a time of limited competition; there were no big box stores, cyber competition or aggressive foreign competitors. Credit was granted only as a last resort, and credit terms were tightly controlled and designed to limit a company's risk. If customers failed to pay on time, they were cut off from further credit and potentially "blackballed" by others.

The natural outgrowth of this economic climate was the view that credit management was aligned with risk management and the KPIs were DSO and percent of bad debt. This view was therefore appropriate for the times.

However, the current economic climate is radically different from the post-WW2 era. Rather than shortages, now there are more goods and services available then ever before in human history with more on the way. Quality in products and services is a given expectation and for businesses to be competitive they must also have quality business processes.

Yet, today many businesses still cling to the old credit philosophy of the past and track DSO and percent of bad debt. But in doing so, they are missing an opportunity to increase sales, improve cash flow, control losses, elevate customer service levels and customer retention, and decrease their cost of doing business—all of which contribute to profit enhancement.

The notion of risk management that ruled in the 1950s was applicable for that time, but this is 2005. We must rethink the role of credit.

Using Credit as a Sales Support Tool

Credit is extended when a product or service is sold on the basis of payment at a later date. The extension of credit creates additional administrative costs such as information gathering, credit checking, account establishment, billing ,and past due A/R management. There's also the cost of carrying A/R, the time value of money. Finally the customer may fail to pay and with that comes the cost of bad debt write-offs.

Some people will tell you that costs are incurred because customers require time to ensure they got what they ordered and more time to process the invoice. Others will tell you that customers need time to add value to the products or services they are buying, and to make sales to their own customers. Finally, some will tell you that they must incur the costs of credit because it's the customary way of selling in their industry, and that if they don't extend credit, their competitors will.

However, the only reason a business should extend credit is to generate a sale that would otherwise be lost—not just any sale but profitable sale. Any fool can make sales and lose money doing so.

Thus the purpose of credit is sales support. It is not an accounting function.

Major Components

In most cases the credit-to-cash function can be broken down into four major components:

  • Credit/sales approval
  • Billing
  • A/R management
  • Monitoring and improvement

Each component must have a goal which compliments the purpose of the credit-to-cash function itself. Unfortunately most companies view the first three items as separate and distinct business functions while the fourth component is ignored altogether. If the credit-to-cash cycle is not viewed as a single process with individual components that contribute, in their own unique way, to the success of the whole, this critical cycle will consistently fail to achieve its full potential.

Credit/Sales Approval

Despite the investment and the goal of extending credit, the credit approval process has, at times, been described as finding ways to say "no" and the credit department has been referred to as the "sales avoidance department". Moreover, considering that credit people are being told (via performance measurements) that risk avoidance is the goal, it's surprising that any customer gets approved for credit.

Avoiding the Wrong Message

A substantial investment is made in getting customers to the point where they want to buy. It's such a waste to then look for reasons to reject the sale and to alienate the customer to the point where they may reject you in the future.

There are three key factors that must be considered during the credit approval process. They need to be considered not just at the original sale but on all credit sales

Customer Profile: Who are your customers and, just as important, how do they do business?

Past Performance: Has the customer ever paid anyone in the past?If they haven't what makes you think you're going to be the first? As the late former US president, Ronald Regan, said "Trust but verify."

Product Value at Time of Sale: If you are operating below capacity, the only expenses that matter are variable costs. This is true for both a service as well as product-oriented environment. The actual profit margin for these incremental sales is therefore higher, sometimes substantially higher. In order to fill this excess capacity, you can adopt very aggressive pricing models or relaxed credit terms. The write-off rate may be higher, but the incremental profit more than makes up for the added risk.

Sending the Right Message

The credit approval process should be to maximize sales opportunities wherever possible while minimizing risks. Working to find ways of saying "yes" to every possible sale while remaining confident of payment better complies with the sales support mission.

Most people treat credit approval as a fixed point in time with a fixed set of operating characteristics. Once a prospect has overcome all of the credit approval hurdles that inhibit the desire to place an order, the prospect is then assigned a credit line. However, this, in most instances, acts more as a deterrent to new business from the prospect than as a protection against increased risk.

For example, if a customer likes your products or services and wants to order more than either party had originally anticipated, credit line place a temporary cap on the ability to expand the relationship and do more business with you. What's wrong with this picture? Good customers with whom you want to do more business should not be impeded in any way and yet the desire to "protect" revenue has done just that. Good customers should be allowed to place their orders easily and permit the sales-to-cash cycle flow evenly into the billing process.


Credit/sales approval supports the sales process, but that's just the first step in the sales-to-cash cycle. Profitable sales cannot be achieved unless payment is received. A funny thing about selling on credit is that when you don't send an invoice (or send one that makes no sense), most customers won't send you money. The goal of billing is to facilitate payment, and to do so the billing must be timely, accurate, complete (according to the customer) and understandable. Finally, invoices and the original credit terms should reflect a late charge for late payments. If there is no late charge, there is no set term for payment, and no motivation on the part of a customer to pay on time.

A/R Management

At this point, the sale has been motivated by enlightened credit management; an order has been received; goods shipped or services provided; and an accurate and timely invoice placed in the customer's hands. A profitable sale is almost within grasp and will be achieved once this invoice has been paid. The gross margin, as calculated from the invoice, is now at its highest point, but will deteriorate slowly as time passes and the customer fails to pay on time. However, what cannot be stressed enough is that A/R Management is not "collections", the enforcement of payment. Collections is what collection agencies and attorneys do. They deal with "debtors", not customers.

A/R Management is "the completion of the sale". The primary goal is to keep customers current and buying, and in that process is crucial to achieve one of the most important underlying goals: the stimulation of repeat sales. The last thing smart companies want to do is create an impediment to lucrative, repeat business.

The secondary goal of A/R Management is the early identification and control of the small percent of credit customers who represent a potential for loss. Every past-due customer will fall into one of three categories.

Type 1: Slow Pays. Some customers practice tight cash management and deliberately pay late. Other customers may be disorganized, lazy or indifferent to paying on time. These are customers whose business is desired and profitable.

Type 2: Problem Accounts. The problem can be something going wrong or the customer not having the ability to pay. System problems, or things going wrong often make up the largest percent of all past dues. Financial problems are either short term (temporary) or long term (serious). We want to work with the financial temporaries and encourage their continued business and we want to cut off further credit to the financial serious who represent a 90 percent-plus risk of failure.

Type 3: Avoiders. This type of customer is constantly trying to beat you out of your money. It is also the smallest percentage of all past-dues. Rather than wasting time (your most precious resource) fighting for payment, cut off credit and refer this account to a "real" collector; an enforcer of payment.

Everything else being equal, people buy from someone they like. The exact same rule applies to payment. Remember: people pay those they like first.

This is part one of a two-part note.

Part two will discuss measuring and improving credit and A/R management.

About the Authors

Charles Chewning, Jr. is president of Solutions, a Richmond, Virginia-based (US) consulting firm specializing in accounting software selection. He is considered a leading software selection expert. Chewning has written a number of accounting software reviews and is a frequent speaker on the subject of accounting software selection as well as sales and marketing. He is the publisher of The Accounting Library (

He can be reached at

Abe WalkingBear Sanchez is the president and founder of A/R management Group ( and developer of the copyrighted Profit System of B2B Credit Management. An international business speaker, WalkingBear has spoken to over 600 CEO and top managers groups worldwide in the last ten years.

WalkingBear can be reached at

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