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There is a better way to manage your Credit Department, it just hasn’t quite been invented yet …..

Ron Wells



Change is advancing upon us on all fronts, not least in respect of credit and receivables management. The change referred to is not the sort of ripple experienced in the past, it is a seismic wave of inconceivable power and implications. It is the fabled 'third wave' and - as Canute the Great may have said, when the tide washed in over his feet - “Let all know how empty and worthless is the power of a credit manager, for there is none able to prevent the 'tsunami of change' from sweeping away the dearly loved 'status quo'.”

This article is an appeal to Credit Professionals everywhere to mount the surfboard of innovation and ride this wave of change at its leading edge; or be swamped on the beach. The sandcastles of status-quo-credit-management-methodology carefully crafted day by day will soon be swept away, despite all protestations that, 'it has always been done this way', or 'this is the only way to do the job'.

 “The networked economy (is) besieging the old world with the most sophisticated weaponry ever seen.” 1 In the words of  Prof. Richard Scase, the third wave is a tidal wave … “creating a new culture of how we do business; a new culture which is based on an anti-business business approach, a culture of business which is very much twenty-first century, unlike the culture of management which we have today, which is often nineteenth century for many businesses”. 2


Commercial Credit Management - Today

In the early 21st Century commercial credit management is still very much a mixture of art and science. It is almost exclusively focused on the day to day micro-management of individual customer receivable accounts or individual sales transactions.

Chief Financial Officers and Corporate Treasurers gaze enviously at the retail sector (mainly credit card companies and retail banks) and long for the day when they can sweep away their archaic, non-core credit and receivables management structures.

“There can be no vision of the future, but there can and must be a vision for the future: a new barbarian vision. A future that isn’t there yet, can't be discovered. It is created by men and women of vision, who are faced with the simple choice: to create their own future, or fall into somebody else’s (and) be at the mercy of another’s whim.” 3  


Commercial Credit Management – The Near Future

It is already possible and feasible for companies to outsource most of the activities traditionally associated with in-house commercial credit management.

Commercial credit activities that can be outsourced include: 4



Credit Analysis,

Management Reporting,

Accounts Receivable,

Legal / Bankruptcy,

Cash Applications,

Customer Visits,

Supplier Analysis,



Analysis Beyond Credit,

Billing / Invoicing,

Credit Scoring,

Customer Service,

Global Risk Management,

Inventory Control,

Cash Forecasting and

Cash Flow Management.


Many corporate or commercial credit managers will be horrified to think that “credit analysis” could, indeed will be outsourced. Most have progressed their careers based on expertise in this area, they love financial analysis, it’s what they do well, it’s what they live for, it’s what they are …. Hence the changes will not come easily, many will resist, but the power driving the change will prevail.

Commercial credit managers will be left with five main areas of activity, namely: 4

1.      Developing Credit Policy.

2.      Setting Credit Terms.

3.      Managing Trade Finance Bank Relationships.

4.      Managing Receivables Service Providers.

5.      Working Capital Management.

This will bring a different emphasis to the job, macro-management will become more important than micro-management.


Commercial Credit Management – The Not Too Distant Future

The new rôle for the commercial credit manager will be at the heart of the business, managing what for many companies is their largest single asset, the Accounts Receivable (A/R) Portfolio. 5

Credit managers may look forward to the day when they take their rightful place on the Executive Committee, as the strategic manager of the significant investment in Accounts Receivable, and of the risk profile of that investment.

A/R Portfolio management tools are available, and others will soon be invented, to enable credit managers to manage the Cost of Capital, while providing improved transaction-by-transaction Competitive Advantage.

Cost of Capital

The Cost of Capital is the average cost to a corporation of borrowed funds (bank loans for example) and equity. In practice it is a function of the lenders’ and investors’ perceptions of the risk inherent in the business.

In the case of any company that owns and operates a significant investment in A/R, it follows that;

·        the higher the Receivable Portfolio risk, the higher the company risk profile, and

·        the higher the company risk profile, the higher the Cost of Capital.

A higher Cost of Capital necessarily leads to lower Total Shareholder Return; that is poorer performance.

Thus the quality of management of the A/R Portfolio has a direct impact on overall corporate performance. Of course the quality of management of credit risk in relation to individual transactions also impacts corporate performance on a cumulative basis, through its impact on gross turnover figures and bad debts written-off. However the micro-management of customer accounts does not have a high profile at CFO and CEO level. How many credit managers have been promoted to Chief Financial Officer or have a place on the Executive Committee? None, is probably the answer but that will change when credit managers raise their status through strategic A/R Portfolio management.

New Credit Management Tools

Two essential tools are needed to make possible the effective management of A/R Portfolio risk, and the efficient provision of Competitive Advantage to the Sales Force in commercial undertakings. These tools are;

1.      Trade Credit Ratings of customers, to enable Portfolio Credit Risk analysis, and

2.      a mechanism to separate the Trade Credit Payment Risk from each transaction or from categories of transactions, to enable the ‘sale’ and ‘trading’ of that risk to and among a large number of investors.


Trade Credit Ratings

The need is for an independent, neutral rating of a company’s ability and willingness to pay for supplies of goods and services (Can pay? Will pay?).

The most widely known ratings that exist today (those produced by the big three agencies; Standard & Poor’s, Moody’s and FITCH) are for the most part designed to provide an evaluation of risks related to money market traded instruments, such as bonds. They work well for that purpose but are not appropriate to use in relation to trade credit.

In any event such ratings are not widely available, since they are paid for by the company being rated, and/or they require the availability of International Accounting Standards (IAS) compliant, audited financial statements.

The majority of corporations do not issue debt instruments, hence have no motivation to pay for a debt rating, and the majority of businesses do not make their financial statements available to the public.

The Lack of Financial Statements should not be a Show-Stopper

It is clear to many experienced credit professionals that the information available from an analysis of financial statements has very limited usefulness, as a means of forecasting whether or not a buyer will pay for goods or services supplied in the future. Competent management, with an effective strategy, will make a success of a financially ‘weak’ company. However dishonest or incompetent management will reduce even a ‘strong’ company to ruin.

The third phase of a study by von Stein and Ziegler (1984) “attempted to identify the characteristics and concrete behavioural indications that distinguish failed firms from solvent ones. The qualities found to set failed company management apart (from those in the non-failed group) were the following:

1.      Being out of touch with reality.

2.      Large technical knowledge but poor commercial control.

3.      Great talents in salesmanship.

4.      Strong-willed.

5.      Sumptuous living and unreasonable withdrawals (of cash from the business).

6.      Excessive risk-taking.

The management of solvent companies were found to be more homogeneous than (those of) failed companies and seldom showed a lack of consciousness of reality. The authors recommend all three components of analysis (balance sheet, account behaviour and management) be pursued to assess a company.” 6

Knight (1979) analysed the records of a large number of small business failures as well as conducting interviews with key persons involved. Knight (found that) some type of managerial incompetence accounts for almost all failures.” 6

Given these reports and other anecdotal evidence, it would seem that the gathering and systematic analysis of non-financial information about buyers could form a better basis upon which to rely when making trade credit decisions, than pure financial analysis.

In practice today credit managers; analyse financial information with a degree of scepticism; gather payment behaviour information both internally and externally (through credit agencies or direct credit references), and make a largely intuitive assessment of management ability-honesty. This unstructured mixture of science and art then produces an individual credit decision from the alchemy of each individual’s brain - as if by magic.


New Credit Management Tool Number One

What is needed is for this process to be systematically and consistently carried out by a neutral, independent agency; on behalf of sellers, banks and investors at large. 7

The Basel Committee on Banking Supervision proposed in January 2001 that External Credit Assessment Institutions (ECAIs) should be licensed to produce such credit ratings for banks. This will enable banks to reduce the amount of capital allocated to higher rated corporate financing, thus increasing bank Risk Adjusted Return on Capital (RAROC). 8 With this type of motivation, ECAIs should soon become a reality. ECAI ratings could be used by sellers and investors, as well as banks.


Payment Risk Trading

“One day very soon, a salesman will call his credit manager, and ask for a credit limit on a new account.

The credit manager will look up the quoted price for credit default protection on the new buyer, from his favourite website.

The credit manager will grant a credit line with an internal credit charge of say 0.1% per shipment (0.6% / 6 shipments per year).

The salesman will factor the internal charge into his quote to the customer.

As goods are shipped,  the credit manager will purchase credit default protection on the customer, thus hedging his company's exposure, and transferring the risk to the credit derivative marketplace.

Note that the credit manager;

·        will not read a credit report,

·        will not consult an in-house analyst, and

·        will not post a credit loss reserve.

All the information he requires about the buyer, will be captured in the market price for default protection.

The process is breathtakingly efficient.” 9

The process described is not only “breathtakingly efficient”, it provides a means to cover trade credit payment risk that is flexible enough to enable dynamic A/R Portfolio risk management.

Unfortunately Credit Derivatives as they have been structured for use by banks and investment funds – formalised by the International Swaps & Derivatives Association (ISDA) – are not appropriate for use in relation to the vast majority of trade credit payment risks.

EnronCredit (now defunct) realised this and designed a “Digital Bankruptcy Swap” to answer the perceived shortcomings of the traditional Credit Derivative. However the market for Digital Bankruptcy Swaps was too illiquid and narrow to meet the requirements of commercial credit managers generally. In addition “bankruptcy” is only one of the conditions that a commercial credit manager seeks to protect against; “late payment” is another important negative condition. “Late payment” was not covered by a Digital Bankruptcy Swap.


New Credit Management Tool Number Two

What is needed is a standardised, transferable instrument that enables the payment risk inherent in individual trade transactions to be carried and/or traded by participants in the capital and money markets.

Thus the ‘origination of transactions’ – manufacture and marketing - could be separated from the ‘bearing of trade credit risk’, in a way which would enable many investors to compete to minimise the cost of carrying trade credit, and to spread the payment risk.



The future is created through …


Commercial credit managers should set aside time to raise their eyes from today’s transactions, to think about what would make their jobs more meaningful, and to start inventing the future.

Ron Wells 



1.    Corporate Voodoo © 2001 Rene Carayol & David Firth.  Capstone Publishing Ltd.

2.    Richard Scase - Professor of Organisational Behaviour at the University of Kent. Read the full text of his speech at:

3.    The New Barbarian Manifesto - How to survive the Information Age © 2000 Ian Angell.

4.    Lists from The Credit & Financial Management Review  -  Volume 3,  Number 2, 2Q1997, Page 16.   Based on extensive focus groups and a quantitative survey conducted in the USA, during 1996 / 1997.

5.    Read: Portfolio Risk Analysis by Kelly Cundiff  - Director of Market Strategy - Fortune 2000 Corporations - Inc., at:

6.    An International Survey of Business Failure Classification Models – Edward I Altman and Paul Narayanan – Financial Markets, Institutions & Instruments. V 6, N 2, May 1997.  © 1997 New York University Salomon Center.

7.    Read: How One Company Developed Its Own Trade Credit ScoreCard by Mary S Schaeffer (IOMA) January 2001, at:

8.    Read an extract from the: Basel Committee on Banking Supervision Consultative Document "The Standardised Approach to Credit Risk" at:

9.    Vincent Matsui - Director Life and Credit Capital Markets, Swiss Re New Markets - OMNINEWS - September 1999.  

© Copyright 2001-2002  R  K  Wells


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