CHAPTER 2
CREDIT AND COLLECTION OPERATIONS
Chapter Outline
1 Learning Objectives
2 Topics
1.1 INTRODUCTION
1.2 OVERVIEW OF CREDIT AND COLLECTION MANAGEMENT
1.3 ORGANIZING CREDIT AND COLLECTION DEPARTMENT
1.4 THE CREDIT AND COLLECTIONS TEAM
3 Summary
Learning Objectives
1. Note the roles of the various employees of the credit and collection functions.
2. Describe special characteristics and abilities to look for when selecting
personnel.
3. Learn how to build a strong credit team.
1.1 Introduction
Credit and collection activities refer to the granting of credit to customers so that they can defer
payments to the seller, and then collecting those funds at a later date. Ideally, it is vastly easier to
collect payment in advance or on delivery from all customers, but competitive pressures rarely allow
this to be the case. Instead, if a business refuses to grant, as well as the methods required to collect
funds.
In this chapter, we describe the structure of the credit and collection functions, key job
descriptions, goal setting, staff compensation, management reports, and other issues necessary to the
daily operation of credit and collection.
1.2 Overview of Credit and Collection Management
In this section, we describe the problems faced by the credit and collection functions, as well as
how these areas can be organized. Both functions impact the performance of other parts of a company,
which can result in some political maneuvering to see who controls them
The Credit Conundrum
The credit department is arguably the most unpopular department in a company. The reason is
that customers want unlimited credit in order to delay cash payments, while the credit manager must
exercise some prudence in only granting credit where invoices are likely to be paid. The result is two
types of risk:
▪ The risk of granting too much credit to a customer that cannot pay.
▪ The risk of denying credit to a customer who can pay.
It is extremely difficult to maneuver between these two risks and grant just the right amount of
credit, so the credit manager is likely to be abused from all directions. The sales department believes
that the credit manager is stifling sales, while the chief financial officer believes that the extension of
too much credit is resulting in outsized bad debt losses.
Further, because of the confidential nature of some of the information used to reach credit
decisions, the credit staff may not be able to fully explain the reasons for its decisions to the sales
department. The result is ongoing frustration on all sides, which can result in the credit manager losing
all power and eventually just “rubber stamping” all requests for credit. This scenario can only be avoided
through the ongoing support of senior management, which most understand the key role that the credit
department plays.
1.3 Organizing Credit and Collection Department
The nature of a business and its size will determine the structure and staffing of the credit and
collection department. Unlike most other company operations, the credit department tends to remain
fairly constant in size and scope of activities during periods of changing business conditions. This is
due to increased support needed for full volume sales in good times and for increasing delinquencies
when economic times are difficult. A credit department may face a greater number of collection
problems in a depressed economy when inflation is rising and the money supply is tighter. During
prosperous times, new account volumes create more upfront work for the credit department.
The collections team can be considered the janitor and sweeps up after the other parts of a
business have completed their work. The analogy is an apt one, for any number of problems may have
been caused by other parts of the business, such as incorrect billings, flawed product designs, or
damaged goods, which the collections team must work around during its efforts to collect cash from
customers. This means that the collection effort may seem inefficient, due to problems that are outside
of the control of the collections group. Only by giving feedback to the rest of the company can the
collection manager achieve reasonable collection results. Thus, collection management requires
expertise in dealing with other departments, as well as collection skill.
The organization of the department is particularly important; a measure of permanence and
stability must be achieved that will ensure that the department functions under all conditions. Although
the organization should not remain static, it is highly desirable to have experienced and capable
employees available within the department. The credit manager should strive to achieve a balance of
newly trained entry-level staff and experienced credit professionals. Alternatives exist to accommodate
extra heavy workloads. Cross-training of personnel can lead to more flexibility. Accounting department
personnel can be trained to perform routine tasks and called upon as necessary and temporary staff
hired or tasks can be outsourced to companies specializing in credit-related functions such as cash
application and dispute resolution.
1.3.1 Organizational Structure
The credit and collection functions may be separately located within different departments. The
credit function is essentially issuing short-term loans to customers, which is a financing function, and
so it may report to the treasurer or chief financial officer. The collections’ function is an extension of the
billing function, and so is more likely to report to the controller. Since this means the two areas are
organized separately, interactions between the two departments can prolong the time required to
resolve issues with customers. To keep this from happening, we recommend that the two functions be
combined into a single department. In addition, consider folding the order entry function (which normally
reports to the sales manager) into this group. By doing so, a large part of customer interactions is
combined under common management, which can shorten the time required to resolve customer
problems. It is rarely a good idea to have this merged group report to the sales manager, since doing
so gives sales too much control over the granting of credit, which will likely be expanded to
accommodate all customer orders.
Centralization vs. Decentralization
Although there may be variations among companies, the control and administration functions
can usually be classified into two types of operations: centralization and decentralization. The question
of whether to centralize or decentralize the credit function is faced by companies with geographically
and culturally diverse operating units. It remains important as corporations continue to reengineer their
business processes to leverage their technology. In a centralized structure, the credit function is
controlled and administered from a principal or central location. In a decentralized structure, the credit
function may report to a principal location (headquarters) with credit personnel located at remote offices.
A. Centralized—Credit Controlled and Administered at a Headquarters Office
A centralized department services credit operations that are based entirely at a company’s main
headquarters. It is the responsibility of the credit manager and staff to approve credit terms on most
orders. Credit professionals may find themselves questioned by sales staff or even upper management
if they decline an application to grant terms on an important or significant order. An increasing number
of credit departments are using automated options that approve credit lines for perceived low-risk
customers or low-amount credit requests as long as they meet certain pre-established criteria. This, in
theory, allows credit managers and staff to focus on the most important customers and situations.
A centralized credit system may be modified in certain respects. In some companies, for
example, most of the credit functions are carried on at headquarters, but collections offices are located
in the field to work directly with customers, secure payments and make adjustments.
Figure 3-1 illustrates a credit department that is administered and controlled from a headquarters
office. The senior ranking credit professional (e.g., director of credit, credit manager, etc.) is charged
with ensuring department responsibilities are met and policies followed. That person is responsible for
reporting to upper management staff, such as the treasurer or chief financial officer, as it is important
for the credit function to maintain close and open communication with those responsible for the greater
financial functions of a company.
B. Decentralized—Credit Controlled at Headquarters but Administered from
Decentralized Location(s)
A mid-management level credit manager reports functionally to an executive-level credit
manager at headquarters and also reports to the division head (the principle is the same for subsidiary
or branch operations). While authority in credit and collection is provided by the executive-level credit
manager, in all other respects middle management establishes the procedures to which the credit
professional must conform. Figure 3-2 illustrates a decentralized operation under which the middle-
level credit manager has a dual reporting role requiring close cooperation between the top-level credit
executive and the division general manager.
Authority of the Mid-Level Credit Manager
The mid-level credit manager is normally empowered by the division general manager to take
care of personnel problems, operating expenses and all other nonfunctional matters within the scope
of local policy. The mid-level credit manager has authority to give final credit approval on all orders not
exceeding a stipulated amount. Orders in larger amounts are referred to headquarters for processing
and approval, usually with local recommendation. The mid-level credit manager may be authorized to
give preliminary credit approval so the order can be processed. Another method is to designate certain
customers as “headquarters accounts” because of special circumstances. When this procedure is
followed, the mid-level credit manager ordinarily has final approval authority for all other orders, and
can recommend credit limits for accounts with sound financial resources whose orders normally exceed
local authorization.
Authority Retained by the Top-Level Credit Executive
The top-level credit executive establishes credit policy for the divisions, considers approvals in
cases that exceed the limits set for mid-level credit executives and is completely responsible for all
headquarters accounts. The top-level credit executive, in conjunction with the accounting and systems
departments, also determines the procedures, techniques and practices to be followed by the divisions
in their credit and collections operations. Training of credit personnel and the assignment of employees
to the divisions, with the agreement of the division manager, are also primary responsibilities of the top-
level credit executive.
Decentralized—Credit Controlled and Administered from Decentralized
Location(s) with a Staff Office at Headquarters
In this type of organization, the top-level credit executive is responsible for collecting information
and preparing reports for management, providing advice and counsel to the field credit executives, and
participating in major problem-risk analysis. Figure 3-3 illustrates a decentralized operation with a staff
office maintained at headquarters. This arrangement requires the top-level credit executives to be
responsible for order approvals and collections and to control their own unit credit departments.
The top-level credit executive usually establishes the overall credit policies. Divisions coordinate
their activities based on industry best practices and select the best alternative action in the light of
prevailing conditions. Compliance with the overall policies is especially important, so telephone calls,
video conferences or field trips are key to monitoring the activities of credit personnel in the field. In
cases where control is completely decentralized, the midlevel credit manager reports only to the division
general manager and has complete authority in all credit and collection matters without reference to
headquarters. The division is required to carry out the general credit policies of the company, but the
operation within those policies is the responsibility of the division. Consequently, the division credit
executive is responsible to the division general manager both for the performance of the function and
for the operation of the division.
Benefits of Centralization
• Economies of Scale. When separate divisions serve common customers, a centralized credit office
can mean a reduction in operating costs and a more efficient income stream, along with enhanced
customer service.
• Consistency and Control. Adherence to standardization of policies, procedures and protocols is
more manageable in a centralized environment. This has the advantage of providing consistent credit
decisions across all business units which minimizes risk of satellite departments having undue
influence. When information about a common customer is centralized, the credit function has more risk
control over bad debt exposure and perhaps increased leverage in collection efforts. Closer proximity
tends to encourage communication between staff members and management. Likewise, updates to
policies, procedures and protocols can be disseminated more quickly.
Benefits of Decentralization
• Internal and External Relationships. Close proximity to customers can enhance a credit
professional’s relationship with marginal customers and lead to developing a better rapport with
customers having a sizable dollar exposure. Being on site with other business functions promotes a
better understanding of business goals and fosters the exchange of information about market and
customer needs. It also enhances communication among departments and reduces the number of
interdepartmental conflicts.
• Involvement in Setting Strategic Priorities. Credit can integrate its objectives with those of sales
and marketing into divisional goals. Also, decisions made at a local level can be implemented
immediately without going through additional levels of review.
1.4 The Credit and Collections Team
Who works in the credit and collection areas? There is manager of each function, as well as
highly specialized clerical staff. In this section, we describe the job descriptions of the credit manager,
credit clerk, collections manager, collector and skip tracer. We also note the importance of using of a
probationary period when hiring employees into any of these positions, since this type of work does not
appeal to everyone.
Credit Manager Job Description
The credit manager position is responsible for the entire credit granting process, including the
consistent application of a credit policy, periodic credit reviews of existing customers, and the
assessment of the credit worthiness of potential customers, with the goal of optimizing the mix of
company sales and the bad debt losses. The position generally reports to the treasurer or chief financial
officer. The credit manager should not report to any position in the sales department, since the credit
function should act as a counterbalance to that department.
The key elements of the credit manager position are as follows, broken down by tasks related
to management and to credit operations:
Management Tasks
● Maintain a department organizational structure sufficient to meet all goals and objectives.
● Properly motivate the credit staff
● Measure department performance
● Provide for ongoing training of the credit staff
● Manage relations with credit reporting agencies
● Manage relations with credit insurance providers
● Manage relations with the sales department
Credit Operations Tasks
● Maintain the corporate credit policy
● Monitor industry trends
● Recommend changes in the credit policy to senior management
● Create a credit scoring model
● Update customer credit files
● Monitor the credit granting and updating process
● Accept or reject credit recommendations forwarded by the credit staff
● Conduct on-site visits with the largest customers
● Monitor periodic credit reviews
● Monitor deductions taken from payments by customers
● Monitor the application of late fees to customers
● Monitor the corporate leasing program
The credit manager should have considerable experience in the credit granting field, probably
having moved up from a credit clerk position. The position can require a college degree, though it is
not necessary. Of more importance than a college degree is an excellent knowledge of credit scoring
systems, financial analysis, and how credit-related laws may apply to the business. The position may
periodically require travel to investigate or build relations with larger customers.
Credit Clerk Job Descriptions
The credit clerk is responsible for not only reviewing credit applications from new customers, but
also monitoring current customers to see if their credit levels should be re-examined. The key elements
of this position are:
● Process credit applications from new customers
● Conduct trade and bank reference checks
● Establish credit limits based on credit criteria
● Maintain records of credit reviews and document reasons for credit limits granted
● Monitor credit usage by existing customers
● Monitor financial and credit condition of customers
● Review existing credit limits at regular intervals
● Provide credit information to third parties upon request
It is not necessary for a credit clerk to have a college degree, though it is necessary to have a
thorough understanding of financial statement analysis and how it relates to the granting of credit.
Collections Manager Job Description
The collections manager position is responsible for all collection activities, including all collection
interactions with customers and the management of collection agencies and collection attorneys. This
manager is also responsible for accumulating information about the reasons for collection problems
and passing the information back to the rest of the company for resolution.
The position usually reports to the controller.
The key elements of the collection manager position are as follows, broken down by tasks related
to management and departmental interactions:
Management Tasks
● Maintain a department organizational structure that can meet all goal and objectives
● Monitor the use of collection techniques
● Monitor payment deductions taken by customers
● Properly motivate the collections staff
● Measure department performance
● Conduct staff training as needed
● Review and approve negotiated settlements with customers
Third Party Interaction
● Provide feedback to other departments regarding collection issues originating internally
● Manage relations with collection agencies
● Manage relations with collection attorneys
● Manage relations with outside skip tracers
A key aspect of this position is to standardize the process used for contacting customers. This
does not necessarily mean a highly regimented process, but rather one in which boundaries for
acceptable collection behavior are firmly enforced. Also, the collections manager must ensure that
customers are uniformly dealt with in a manner that abides by all applicable laws.
One of the more useful aspects of the collections manager position is monitoring the general
trend of collections to see if there is a pattern that may require a change in credit policy. The collections
manager is in the unique position of being able to monitor all collection activities, which makes it easier
to discern subtle increases in days’ sales outstanding across the entire customer base, or within specific
customer concentrations. It can be difficult to allocate time for this analysis in the midst of day-to-day
department operations, but it can lead to credit changes that can ultimately save a company from
incurring inordinately large bad debts.
Collector Job Description
The collector position is responsible for collecting the maximum amount of overdue funds form
customers, which may include a variety of collection techniques, legal claims, and the selective use of
outside collection services. The position is not strictly that of a clerk, since the best collector should
operate with a more independent orientation than a procedure-bound clerk, taking those steps needed
to collect funds. The key elements of the collector position are as follows:
● Stratify collection activities to maximize cash receipts
● Issue drumming letters to overdue accounts
● Use skip tracing techniques to locate customers
● Contact customers regarding overdue accounts and determine reasons for non-payment
● Issue payment commitment letters
● Negotiate the return of unpaid merchandise
● Repossess merchandise when payment is unlikely
● Monitor cash on deliver payments
● Issue credit hold notifications
● Recommend that accounts be shifted to a collection agency
● Process small claims court complaints
It is not necessary for a collector to have any type of college degree. Instead, it is much more
important for a collector to have dogged persistence in contacting customers at regular intervals and
the negotiation skills necessary to extract payments from customers. If the company uses computerized
collection monitoring software and auto-dialers, a collector should be comfortable with the use of this
technology.
A productive collector who enjoys the work is a rare find indeed. These individuals commonly
achieve much higher collection rates than normal. The collections manager would be well advised to
create a special environment for such employees, including especially quiet work environments, some
measure of privacy, bonus pay, and any other inducements necessary to retain their services.
Skip Tracer Job Description
A skip tracer is essentially a private investigator who locates people who do not necessarily want
to be found. The orientation of this position is toward research into a variety of databases, so computer
skills are paramount. Work hours can be long, and are likely to be self-directed, especially if the skip
tracer works from home.
A skip tracer is more likely to be an introvert, given the amount of research involved. However,
there is also a need for sufficient social skills to extract location information from the associates of a
person who is missing. Obtaining information in this manner requires that a skip tracer be good at
posting the correct questions, listening carefully to answers, and interpreting this information “on the
fly” to obtain additional information with just the right questions.
In short, a skip tracer is a unique individual, whose personality is inquisitive and research-
oriented, and self-directed. It is quite difficult to find a qualified skip tracer, which is why this position is
so frequently outsourced.
Probationary Period
When hiring a person into any of the preceding positions, be aware that credit and collections
activities are not for everyone, so a certain proportion of new hires will not work out. Accordingly, this
is an area in which a mandatory probationary period is useful for deciding whether someone can be an
effective part of credit and collections. If not, it is best for the company and for them if they are
terminated by the end of the probationary period. Otherwise, the rest of the department will be
consumed by the ongoing training requirements, errors, and morale problems of these employees. The
result should be a more cohesive group that is entire comprised of the types of people who thrive in the
high-pressure credit and collections environment.
SUMMARY
This chapter discusses the role of the credit department from an organizational point of view.
Proper structuring of the credit department—from a one-person operation to a multi-tiered,
multifunctional entity—ensures that the role of credit contributes to the overall success of any company
regardless of size. The role and responsibilities of each member of the team for the proper functioning
of the department and the different types of operations; Centralized and Decentralized structure.
Centralized credit departments are entirely based in the company’s main headquarters.
Decentralized credit departments are not housed in the headquarters, but report to the headquarters
from a remote office or offices. The role of the mid-level credit manager and the top-level credit
executive play similar roles over decentralized and centralized organization structure. However, their
authority and duties may differ depending on the credit policies enacted by the credit department. The
benefits of a centralized credit department include: – Economies of scale – Consistency and control.
The benefits of a decentralized credit department include: – Internal and external relationships –
Involvement in setting strategic priorities.
