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Jul 01 2014
Credit Policy - It's as Simple as Taking a Picture!
Erik Wright, CBF, Spectrum Engineers, Inc.

We have all been there. Sitting on the sideline of our child's sporting event, trying to capture that perfect moment. What we get back does not resemble what just happened at all. This experience convinced me that I needed a new camera, one that allows me to set the parameters. But then I needed to learn how to manage the multiple functions of a more technical camera so I could get the shot I want. It's not unlike credit. We don't want anything outside our control, but by the same token, managing credit exposure can be difficult if we don't understand what impacts it. In photography, you control the light. But there are lots of ways to do that.


With credit you have to control risk and there are many options to do that. It isn't as simple as a point-and-shoot camera. If you only use that approach, your results may be less than you hoped for. I would like to focus on a few lessons I have learned that may help you establish a new policy or revamp your existing credit policy:

1. What is your company's appetite for risk and where is your risk?

Depending on a number of different variables such as what your profit margins may be, availability of cash, and temperature of your industry to extend terms, your company's sensitivity to outstanding obligations may vary and may even fluctuate over time.

  • Client relationships in my industry can be very precarious. We are heavily dependent on repeat business. A broken bridge could have severe, long-term consequences. 
  • In many instances within my industry, risk due to credit exposure rests with our client's ability and willingness to pay promptly. This is balanced by due-diligence in understanding and assessing the credit risk of their clients. Typically, if our client is not paid, we are not paid. In fact, many of our contracts are executed with "pay if paid" or "pay when paid" language. Although subtle, there can be a significant difference. However, even if this verbiage is not in our agreements, it is often implicit that our payment is contingent on our client being paid first. So knowing who the customer is and where the money is coming from to finance the project are critical in understanding our inherent risk of exposure when we take on a new project.
  • Often times financing might not even be in place when the project begins. Loans necessary to pay for our work may be contingent upon getting the proper permits/zoning for a project, or they may still be looking for investors. This added risk only reiterates the importance of knowing who we are doing business with (whether directly or indirectly) and that our contracts are made with the appropriate firm and/or individual.

2. What is the size of the sale or amount of credit extended?

Perhaps this is similar to your credit approval process. Allowing too many outstanding obligations to slip by will impact cash flow and may not be sustainable while too few being approved may also inhibit growth.

  • Understanding your client's capacity to repay is critical to the amount of credit you extend.
  • Many of our client's customers are investors who are usually highly leveraged. They try to maximize their profits by minimizing their out-of-pocket expenses by financing their projects on borrowed money including money floated by our client and ultimately, floated by us. I have to ask, can our client's cash flow sustain this?

3.       What is the duration of sale, contract, or project?

This is comparable to your collection process. Knowing how soon to react to an account is critical and recognizing when you have the most leverage to prompt payment is key. The duration of a sale or life of a contract or project can vary, so do your windows of opportunity.

  • Since default is an uncertain event that can occur at any time during the life of a contract (risk), we need to consider not only the contract's current credit exposure, but also potential changes in the exposure during the contract's life. Equation: Actual Exposure + Potential Exposure = Total Exposure. 
  • When payments are not received at the appointed time, our actual exposure increases as our work continues. Knowing when you have leverage and using that leverage is critical.
  • The sooner we are able to be paid the more we can save on interest bearing liabilities. Capital is then more readily available to assist in the growth of the firm and to satisfy other obligations.
  • Likewise there are other conditions that may extend the duration and have an adverse impact on total exposure such as: undocumented change orders, delayed zoning and building permits, disputes, financing not in place for the project, unclear scope of work, undefined payment terms, and contracts that have not been finalized with all parties. 


It is important to recognize that exposure is just a part of the equation when defining your credit and collections policy. More importantly, the credit and collection policy should facilitate not retard obtaining any new projects or clients. With the right measures in place, any risk can be mitigated to ensure profitability. A change in one element of your exposure will impact the others. This means that you can never really isolate just one of the elements alone but you always will need to keep in mind the impact that one will have on the other.


I think often times we find ourselves complacent in auto-mode managing our portfolios and not necessarily utilizing our credit policies to their potential. Just like the simple camera, the results may be less than satisfactory.