Relevance of Credit Management in Economic Development - Coursework Example

Relevance of Credit Management in Economic Development Student’s Name: Student’s ID: Institution: Lecturer: Date: Executive Summary Credit management is an integral part of firm’s profitability and economic development at large. Financial institutions form an important segment that determines the success of other sectors in any economy (Torre, Martínez Pería, & Schmukler, 2010). Most institutions rely on banks and other financial services providers for capital among other services. When the sector is successful, others become prosperous as well. This is why the governments emphasize on professionalism in financial institution than any other sector (Lodge & Wegrich, 2011). To realize success, financial institution should embrace effective credit management since it is the core function. When this is not done, all is not well since the firm is likely to collapse due to bad debts. In order to have effective credit management in an institution, aspects such as hiring credit professionals, credit policy and efficient lending process should be considered. In absence of these aspects, it is most likely to experience bankruptcy in the sector and the entire economy (Perkins, Radelet, Lindauer, & Block, 2012). It is therefore important for every key player in the finance sector to ensure that basics information concerning effective management of credit function is available. Performance of any financial institution is determined by credit manager and the whole team. Aspect of team work is therefore crucial since they consult each other in regular basis (Michalski, 2013). When there is positive performance, the institutions create public confidence with the sector thus encouraging people to look for business capital from them. In the long run, the trend impacts the whole economy by improving the performance of both corporate and individual credit customers. Table of Contents Executive Summary 1 Introduction 3 Aspects of Effective Credit Management 4 Need For Effective Credit Policy 7 Recommendation 9 Reference: 11 Introduction Credit management is a managerial function within an enterprise that facilitates the process of controlling and collecting outstanding debts from firm’s clients. In addition, the function controls credit purchases from suppliers (Chor, & Manova, 2012). This entails ensuring that customers pay their debts when they become due. The staff in charge of this critical function has an obligation of ensuring that credit cost is low and does not have negative impact on the profitability of the enterprise. Credit function can either make the company prosper or cripple depending on its strength. To some extent, it affects wider sector or even the whole economy (Chor, & Manova, 2012). Global financial credit remains a relevant lesson on how poor credit management can make the whole world suffer. This implies that credit sector should have an efficient management in order to function properly thus enabling institutions to perform profitably. The management is responsible for drafting realistic credit policies as well as implementing them. This safeguards the institution from aspects of bad debts and it also attracts more customers. It is evident that most businesses rely on credit to facilitate their day-to-day operations (Michalski, 2013). In respect of this, financial institutions should exercise high level of professionalism in advancing credit to their customers. To have efficient credit management function, an institution ought to have specific team that deals with credit. This team should consist of experts who understand the power behind good credit practices as well as danger of malpractice in the same section (Saunders & Allen, 2010). The team designs the credit policies in consultation with senior management. It also guides the institution in implementing the same policies. Aspects of Effective Credit Management Note that credit management function has a direct relationship with financial management in relation to movement of firm’s products. It also defines how close the firm is to the customer. In this regard, the institution should ensure that it observes aspects of effective credit management when carrying out its operations. This is because the function directly touches on institutional current and future cash flow (Saunders & Allen, 2010). With poor credit management, it is possible to have attractive books of accounts indicating high profitability while in real sense the company is collapsing due to lack of liquid cash to run its affairs. This happens when too much capital is tied on bad debts and the credit function is unable to collect debts from customers (Chor, & Manova, 2012). Therefore, institutions should take utmost care when recruiting staff to perform credit management functions. To ensure there is effective management of credit in an organization, the function should have an ideal manager. This is the person who understands credit management practices and how the same affects firm’s operations (Torre, Martínez & Schmukler, 2010). A good credit manager is the one who is able to interpret figures in financial records and take necessary action. The manager should also possess both inter-personal and communication skills. This is because the task requires one to build relationship with different types of customers as well as strike deals during business negotiations. To ensure the credit manager makes accurate decisions, he should possess information regarding relevant laws affecting credit operations. When one has all these qualities, the institution is sure of effective management of credit thus profitable business. With effective manager in place, lending institution is sure of credible management in that particular section. To get the best results, one must have integrity in every step throughout the lending process (Torre, Martínez & Schmukler, 2010). Once prospective customer expresses the desire to take a loan, the credit staff should apply utmost caution during the assessment period. This is the most ideal stage in lending since it determines the fate of the whole process. This is where the credit staff establishes whether the client is creditworthy or not. The staff in consultation with the manager determines whether the client is able to meet the obligation of the amount he or she is applying. Once you establish the credit rating of the customer, the manager need to ascertain how much the same customer is able to pay without unnecessary struggle. The manager may ask several questions that lead to accurate judgment. How much is the customer applying? What kind of collateral is he or she giving against the loan? How is his credit history? How promising is his income generating activities? How is his lifestyle and spending habit? All these questions are vital in the process of assessment and the credit team should analyze them before advancing the loan. When the manager conducts the process diligently, he can therefore expect smooth repayment from the customer. After successful assessment, an institution ought to observe collection discipline. This is where the credit team sticks to deadlines. The team led by the manager should ensure that it collects every debt that is due without delay. This is possible when the customer gets a reminder in good time so that he or she can make proper arrangement to pay. This stage entails constant communication with the customer. The communication helps the institution to sustain good relationship with its clients as well as avoid excuses for late payments. The credit team should ensure that rate of late payments is low to avoid conflicts with customers. Note that when customers pay penalties for late payment, it is likely that this customer gets dissatisfied. To prevent this, the credit team needs to maintain constant touch by reminding the customer several times. However, one should exercise caution to avoid being troublesome or a bother to the client. When customer pays on time, the team should ensure it communicates its appreciation to him. This acts as an encouragement to the same customer thus he develops morale to be paying on time. In case of late payment and penalty, a good credit manager takes the customer through financial counseling process. This includes ways of preventing late payment thus avoiding penalties. Such move creates sense of worth to the customer hence maintaining good relation even after charging him a penalty (Torre, Martínez & Schmukler, 2010). Note that many might think the institution is interested in their penalties to make profit which is not true. Sustaining the customer is more important that making huge revenue from him then losing him after final installment. Customer should always be aware that the institution has no interest in charging penalties. By doing this, there are good public relations which benefit both the customer and the institution thus impacting positively to the whole economy. On the contrary, when customer develops a habit of late payment which attracts penalties, he or she tends to believe that the institution is not suitable. This is because customers end up paying more than what they had previously planned which reduces their revenue. At the end of the day, they fail to sustain their businesses which end up collapsing if the situation persists (Saunders, & Allen, 2010). In the long run, the institution loses the customer and this forms a trend which may make it insolvent. This cycle affects the economy negatively since businesses collapse thus no revenue to both the government and its citizens. At this stage, it is clear that the back stops at effective credit management. However, it is possible to have the right team in place and stiff fail. This happens when there is no effective policy to provide guidelines in lending and collection process (Saunders & Allen, 2010). A good example is the severe and unfortunate case of global economic meltdown. The government aimed at providing cheap mortgage to the general public which resulted to massive default (Caouette, Altman, Narayanan, & Nimmo2011). Value of collateral was below the amount defaulted and costs incurred by the lending institutions. Such policy led to painful circumstances which crippled most sensitive sector in United States and it affected the world economy (Saunders & Allen, 2010). This case serves as a good example and ultimate reason why financial institutions should have efficient credit policy. This policy enables the financial institution to advance credit to deserving clients only. In addition, every prospective client is allowed to apply the amount he or she is able to pay instead of giving huge loans to customers without considering their credit rating. Need For Effective Credit Policy The main aim of developing an effective credit policy is to provide general guideline in lending and debt collection. It enables the institution to measure the credit risk and to reduce exposure to bad debts. To do this, the policy outlines terms and conditions which the credit team applies when advancing credit to customers and also when customers are applying loans. In addition, it spells out the collection procedure and consequences for loan default. The policy can make the institution to either fail or succeed in lending business. This depends on its effectiveness since it directs the whole exercise. This implies that the institution should consult relevant experts when developing credit policy. Most institutions fail not because of staff inefficiency but due to weak credit policies (Saunders & Allen, 2010). They end up with records showing profitable prospects but huge amount of capital in form of unpaid debts which are irrecoverable. In this case, the institution is thrown out of market. When the credit team is able to interpret the policy accurately, it defines institution’s target market. This is because the policy describes attributes of prospective customer in terms of requirements. Effective credit policy should therefore be adaptive to the actual economic environment in order to respond to prevailing market needs (Caouette, Altman, Narayanan, & Nimmo2011). To have such policy, the institutions within the financial sector of economy should invest heavily in research. This paves way for actual feasibility study which makes the policy suitable and applicable. As a result, the institution is able to attract potential customers since it targets viable projects in the market. It is able define and meet what the market needs. Conclusion Credit management is among the critical functions that every institution needs to handle with utmost caution. It is clear that most organizations both commercial and non-commercial operate in credit. This is because they may not have sufficient capital to cater for their daily activities. In this regard, they opt to take loans from financial institutions where they can repay in monthly installments. Since this aspect has become a norm in the world of business today, financial institutions need to build strong credit team. Most banks across the world are utilizing credit function to maximize revenue hence high profits. This is due to ever rising demand for loans and other credit products such as mortgage and over-drafts. At the same time, some have collapsed due to poor management of credit function. This happens when the institution has weak credit policy or when the function is handled by the wrong team (Caouette, Altman, Narayanan, & Nimmo2011). In order to utilize this readily available opportunity, it is high time for the financial institutions to embrace credit as a marketing tool. By having the right team in place, it becomes easy to attract potential customers since most business organizations are looking for suitable financial partners. Other banking activities rather than credit may not generate sufficient revenue to sustain financial institutions. This implies that these institutions cannot be profitable without credit. It has become a core product which caters for over 50% of revenue hence high profit. Many financial institutions in developing economies have realized this fact and are taking necessary steps towards increasing accessibility to credit services (Caouette, Altman, Narayanan, & Nimmo2011). Strong economies are emerging especially in East Africa due to this fact where banks are positioning themselves by developing credit products suitable for this specific market. Likewise, in highly developed economies such as Australia, banks and other financial intermediaries embrace good credit practices to sustain positive growth. Recommendation To achieve the desired objective in business and economy at large, effective credit management is not an option. Financial institutions and relevant regulatory agencies should develop strict credit policy that creates opportunity for growth and development. This is where the laws encourage good credit practice and makes the credit available to all while setting certain standard to guard institutions against bad debts. Besides policies, institutions should ensure it has the right team to handle credit matters. This is where credit professionals are utilized in every aspect of lending and collection process. Consequently, an institution is able to exhaust its available resources and generate sustainable profits through efficient credit management. Motivation of the credit staff is also another vital aspect that affects the profitability of financial institution. The institution should ensure that the team handling credit is satisfied by all means to facilitate their stay in the organization. This facilitates continuity and smooth operation since customers are handled by the same people for long period of time. Note that high staff turn-over is dangerous in credit since follow-up is critical in collection. The industry regulator should encourage sharing of vital information among different financial institutions. This is the most suitable way of learning among credit professionals in these institutions since different ideas are shared and common issues discussed. The regulatory body should create this important platform to enhance sustainability and economic prosperity. The regulator who is created by the law is therefore a key player in the industry and should embrace professionalism in all activities to facilitate efficiency in credit management. Reference: Caouette, J. B., Altman, E. I., Narayanan, P., & Nimmo, R. (2011). Managing credit risk: The great challenge for global financial markets (Vol. 401). Chor, D., & Manova, K. (2012). Off the cliff and back? Credit conditions and international trade during the global financial crisis. Journal of International Economics, 87(1), 117-133. De la Torre, A., Martínez Pería, M. S., & Schmukler, S. L. (2010). Bank involvement with SMEs: beyond relationship lending. Journal of Banking & Finance, 34(9), 2280- 2293. Lodge, M., & Wegrich, K. (2011). Arguing about financial regulation: comparing national discourses on the global financial crisis. PS: political science & politics, 44(04), 726- 730. Michalski, G. (2013). Portfolio management approach in trade credit decision making. arXiv preprint arXiv:1301.3823 Perkins, D. H., Radelet, S., Lindauer, D. L., & Block, S. A. (2012). Economics of development. Saunders, A., & Allen, L. (2010). Credit risk management in and out of the financial crisis: new approaches to value at risk and other paradigms (Vol. 528). Read More