I received a call recently from the accounting manager at one of our smaller clients who asked me about what I thought the credit authorization levels within her company should be. I responded that the credit authorization level depends on many factors. Even if I tried to estimate how much the A/R manager, controller, CFO and the president should all be responsible for authorizing, it would not take into consideration a wide range of important issues surrounding the credit decision. However, what I did try to explain was what I thought is involved in making certain kinds of credit decisions as the first step to determining authorization levels. Here’s my short list for your review and consideration.
1) When the amount is small and the product is simple – Some companies that sell a fairly simple and uniform product, at a very low price, and at a set volume, will probably not ever need to do any extensive credit risk analysis. In other words, if the price is $1 a piece and the most that a majority of the customers generally purchase at a time is 100 pieces, the cost to do any kind of credit research just wouldn’t be a cost effective endeavor. Perhaps the customer service representative on the phone might be the one to make the credit decision between granting credit to established customers and requiring payment by cash in advance (credit card) to new customers. However, as the total amount being purchased increases, this is where we go from allowing the customer rep to give credit up to $100, and say the A/R manager for any amount between $100 up to $1,000. As the requested amount continues to increase, say in this example up to $10,000, this might require the CFO’s approval.
2) Complexity of the product – When I think in terms of a complex product, I’m visualizing one of my clients that sells all kinds of excavation equipment. From very small backyard do-it-yourself koi-pond projects with equipment costing a few thousands dollars, to excavating rocks the size of houses from quarries, running into the millions of dollars. The credit research and analysis of the mining companies that would likely buy my client’s large scale excavators is thoroughly carried out, line by line, by their financial and accounting teams, which may also involve the sales managers, leaving no credit stone unturned. The final decision may still ultimately rest with the CFO or President.
3) Complexity and size of your company – At very small companies, one person could easily wear the hats of 4-5 individuals. The human resources, accounting, credit, and purchasing managers might all be rolled up into one very busy professional. Since that individual is involved in so many aspects of the business, it might make sense for them to be the final decision maker (or next to the decision maker) for all credit decisions. Conversely, at very large companies with many layers of vertical management, the credit decision, might require the approval of several people across a few different departments.
4) What knowledge of credit is required – If your company is not selling products that costs millions of dollars, but each order is enough to cause some pain if it weren’t paid, the credit manager might be the one directing and making the credit decision. The more expert knowledge in credit risk management that the credit professional has, the better equipped they are to handle the range of credit decisions appropriate for their company’s scale.
5) Risk vs. Opportunity – Many credit decisions are tempered against the opportunity to break into a new market or potentially obtain a very lucrative new customer. Although the credit manager may see warning signs and higher than normal risk from all the credit information gathered, the sales director might see opportunities worth taking, which could override the credit manager’s decision. However, working together to minimize the risk as much as possible through the implementation of appropriate credit tools can bring about a joint credit authorization process.
In essence, who will make the final credit authorization often depends on several factors that requires analyzing the complexity of the products being sold, price, competitive environment, and the size of the company.
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This article was edited by Steven Gan.