Measuring a Credit Manager's
Performance. "Measurement is usually
linked to rewards and rewards (explicit or implicit) drive behaviour." (Ron
Measurement is usually linked to
rewards and rewards (explicit or implicit) drive behaviour. Hence Performance
Measures are vitally important as a step towards achieving corporate objectives.
Therefore Performance Measures should be designed taking into account corporate
strategy and objectives.
speaking Credit Objectives align with the overall objective of maximising Total
Stockholder Return thus:
Asset Management (ROCE):
Minimise the Receivable Balance.
Maximise Cash Flow received.
Minimise Bad Debts written off.
Minimise Cost of Capital.
Sales / Turnover (Profit):
Match the Competition.
Provide a Competitive Edge.
Expand the Market.
Performance Measures address the first three sub-bullet points only, i.e.
minimising the Receivable and the Bad Debt amounts and maximising Cash Flow.
However the other value added aspects of the job are equally important
and may not receive adequate attention if not measured.
the Receivable Balance:
A study the
following booklet is recommended - available from the NACM Bookstore (http://www.nacm.org/):
An Evaluation of Techniques for
Monitoring Accounts Receivable
Dr. George W. Gallinger
#151 Price: $25.00 Member Price: $20.00
"This booklet examines 11 different measurement
techniques including DSO, ADD and CEI, through the use of a common dataset for
sales and accounts receivable and shows you how most techniques fail to solve
the sales influence problem. With a better understanding of the shortcomings of
the popular techniques, you can improve your organisation's measure of
collection performance. A Microsoft Excel-format disk is available to allow you
to enter your information into a raw data sheet: number of days in the month,
sales for the month, outstanding receivables balances, and the ageing of the
balances (in dollars). The software outputs graphs and tables. It's easy to run
in Excel (PC version). Booklet, 22 pages, 1995."
booklet makes it clear that all of the traditional measurement techniques are
inadequate and discredited, nevertheless credit
and receivables management professionals generally maintain faith in Days Sales
Outstanding (DSO) and/or Collection Efficiency (or some derivative of these).
There are four reasons for this;
firstly, the Credit function usually reports to an executive who is not a
credit professional, the Treasurer or Chief Financial Officer, whose accounting
or MBA background has instilled a belief in DSO, hence this becomes the imposed
secondly, some of the traditional methods work satisfactorily in times
when turnover/sales Dollars are increasing steadily month by month so they gain
third, computer systems have not been available to handle a better
measurement system (based on individual invoices) particularly in high volume
fourth, if managers use a flawed system they always have a ready excuse
for failing to meet their targets.
last point is not made flippantly. Many people do not like to be measured. Hence
they prefer a measurement system which can be challenged when it does not
produce a favourable result. Of course it is never challenged when it produces a
Cost of Capital:
of Capital is related to the risk perceptions of a company's potential
stockholders and lenders. If Receivables are a significant asset then the 'risk profile' of the Receivable
portfolio is an important consideration. Performance Measures should monitor
the overall risk profile and should be targeted at maintaining a certain minimum
weighted average standard.
Cost of Capital concept arises out of a study of the risk-to-reward-ratio
expectations of the parties that provide business capital.
(bankers) generally require an interest rate that reflects their internal
assessment of the credit risk of a particular loan or financing arrangement.
Bond Holders and Commercial Paper investors usually rely on a third party credit
rating to provide a risk indication and hence a reward (yield or interest rate)
credit risk assessments will take into account the structure of a company's
balance sheet (with particular emphasis on leverage – i.e. the relative
amounts of supplier credit versus interest bearing financing versus equity), the
risk inherent in the assets held (including Receivables), management
capabilities, business prospects and any collateral offered. Therefore – if
the Receivable balance is significant – the 'risk profile' of the
Receivable portfolio will influence the cost of borrowing money to fund business
operations and expansion.
the providers of equity Capital (potential Stockholders) will assess the
risk that their investment may be lost, and they will demand an appropriate
return. Since Stockholders receive no collateral and must expect to be the last
participants to be repaid - should a company fail – they will demand a higher
return than 'Lenders'. Hence equity Capital is the most expensive form of
direct relationship between the cost of capital and the risk profile of the
Receivable portfolio is not widely recognised. However this situation could
change as service companies become more prominent. Service companies tend to
present balance sheets evidencing relatively small amounts invested in Fixed
Assets and relatively large Receivable portfolios.
of Receivable portfolio risk has relatively recently come to prominence in the
banking sector. This is due to proposals to reform the Basle
Concordat and require banks to reserve capital based on the risk profile
of their loan portfolios. Banks must now invent methods to evaluate
the risk profile of their portfolios, on virtually a real time basis, in
order to satisfy their respective Supervisory Authorities and minimise their
Cost of Capital, insuring that returns are maximised.
Measures should be tailored to match each company's objectives. An example would
be "set up an inventory financing plan to enable distributors to increase
purchases by X% in year 2000".
2000 R K Wells