The 4 Cs of credit management
by Josef Busuttil
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Creditors should stop selling on credit to Tom, Dick and
Harry for the sake of increasing the turnover figure. They have to keep in mind
that cash, and only cash can pay bills.
Doing business in a small and highly competitive market, where products and
services are becoming more homogenous than ever before, granting and extending
credit terms and limits may be critical to gain competitive advantage.
Products and services provided by various suppliers and retailers can be
described as homogenous, with low or no differentiation features. If one were
to do a window-shopping exercise in one of our high streets, or walk round one
of our welcoming shopping arcades, it will soon be realised
that as far as brand, functionality, after-sales service and price are
concerned, there is little difference from one retailer to another. Very often,
the selling crux lies in credit terms, the interest-free credit on offer, and
the once in a lifetime buy "now" and pay "later" offers,
promoted prominently on the outlets' windows. This scenario also applies in
business-to-business commerce.
However, granting credit is not only expensive to finance and administer but it
also carries an element of risk: The risk of being paid late or not paid at
all. Therefore, credit should be granted profitably and in a responsible
manner, to the benefit of both the seller and the buyer.
There is no one good or perfect business strategy or practice to grant and
manage credit but the four Cs model of credit management (character; capacity;
capital; condition) is a tool which can help creditors better analyse their debtors.
Character - JP Morgan, a successful businessman, argued that he would do
business with anyone, as long as he was honest.
Selling on credit without knowing the customer simply does not work. It will
only make the turnover figure impressive. The key to doing profitable business
is getting paid on time in order to secure sound cash flow for the business.
Therefore, prior to granting credit to a new customer, a proactive character
analysis should be carried out. The creditor should examine the request for credit
by getting to know the customer.
He should look at his type of business; the size of his operation; the number
of years in the same business; the number of employees; the potential growth of
the customer's line of business; any media coverage about the customer; whether
there have been any previous insolvency records; evidence of fraud; any law
suits against the customer or executive court warrants issued against him; any
history of late payment or whether the customer has drawn cheques which were not
honoured by the bank. A credit application form,
consisting of detailed credit sale terms and conditions, is important for both
parties, as well as information pertaining to credit management as such
information is useful to analyse the creditworthiness
of the customer.
MACM members benefit from an organised and
professional credit management information system by which debtors can be
managed in a responsible and profitable manner. MACM has also drafted a master
copy of a credit application form to be used by the Maltese business community
selling on credit.
Capacity - The second credit management "C" pertains to the skills,
resources and capabilities of the customer. Therefore, capacity analysis should
deal with the background of the customer in terms of innovation, business
acumen, experience and knowledge in his line of business; the capability of the
customer to pay on time; the capability of the customer to get paid on time
himself; the level of gearing of the customer; the competitive advantage of the
customer in his particular market or niche; the market share of the customer;
and other pertinent data that would help in getting to better know the
capabilities of the customer.
Capital - The third "C" deals with financial analysis. With the help
of some financial ratios, the balance sheet and profit and loss account can be
widely used for this exercise. However, for better financial analysis, figures
and ratios should be compared with previous years or benchmarked against
industry peers. MACM provides guidelines to its members regarding the most
effective financial ratios to be used for this exercise.
Nevertheless, a number of local companies file abridged accounts with the
registrar of companies. Abridged accounts offer limited data to the creditor
and the public. Even worse, some do not file their accounts and are getting
away by paying penalties to the registrar.
In view of this scenario, what are the Maltese authorities doing to ensure a
sound business community in all sectors of the Maltese economy? How are they
ensuring better financial transparency? Is the penalty fee charged by the
Registrar of Companies to those registered companies effective?
Limited financial information simply means less transparency, and lack of full
financial disclosure may lead to a higher degree of risk exposure when making
business decisions both to invest in, or grant credit
to, these companies. Basing credit decisions on abridged accounts may lead to
more speculation, financial losses and to a poor cash flow situation among the
Maltese business community, which would eventually affect the economy of the
country.
In my humble opinion, the Registrar of Companies should be empowered to do more
than just fine companies failing to file their accounts accordingly and on time.
In any case, the penalties should be effective enough to serve as a deterrent
and not to serve as a viable alternative to avoid filing accounts.
Transparency, clarity, and accuracy in financial statements are needed to
sustain credibility and to enhance the faith in the integrity of the local
registered companies.
Credibility and integrity would attract new investment to the local market, minimise the risk associated with trade credit, stimulate
economic growth, and improve the unemployment figure of
The argument that abridged accounts help to minimise
bureaucracy for the local business community does not make sense. Companies
still need to produce a full set of audited accounts for their bankers and also
to comply with the Malta Statistics Authority Act 2000.
Condition - The last "C" refers to the external environment of the
customer requesting credit.
Creditors should be aware of consequences affecting customers due to changes in
legislation, regulations, interest rates, taxation, currency rates, economic
slowdown or boom, inflation, unemployment, and changes in other economic,
monetary and legal policies.
Customers may also be affected by changes in technology. The effect of the
internet and e-commerce, which is increasing dramatically, may well affect the
business of customers.
Changes in fashion, customer-buying behaviour, green
issues and other factors affecting the local society may also jeopardise the customer's trading. A thorough condition
analysis would therefore, help to minimise future
late payments and bad debts.
• Mr Busuttil is the director general of the