Terms of Sale and Risk Management
By Michael C. Dennis, MBA, CBF

Changing the terms of sale to a customer is one way that the credit department can help to manage or mitigate credit risk -despite the fact that this tool or technique is used infrequently. The most obvious example of using terms of sale to manage risk involves changing the terms of sale to a customer from open account to COD. However, credit terms changes can be used more subtly to control risk. Here is an example:

Assume that a customer has a $10,000 credit line and net 30-day terms, and that the credit department is no longer comfortable offering that credit limit based on the customer's deteriorating financial condition. Rather than cutting the credit limit in half and possibly losing half the business to a competitor, you may be able to limit risk by changing the terms of sale to net 15 days without changing the credit limit.

The advantage of shortening the credit terms while offering the same credit limit is that the customer must pay more quickly, which in theory will have the same effect as lowering the credit limit. The disadvantage or risk is that the customer continues to buy up to its credit limit and essentially ignores the new Net 15 day terms of sale. One way to "encourage" the customer to pay within the new Net 15 day terms is to offer an incentive [such as cash discount] for them to do so.

One final thought: If your company offers a substantial cash discount and the customer refuses to take advantage of the offered discount then it is possible even likely that the customer's financial problems may be more serious than you originally believed.