Credit Control: Meaning, Types, and How It Works

There are several instances when extra funds can help complete an essential purchase. Lending institutions serve as the conduit for providing financial assistance in emergencies. However, even lenders take considerable risks while disbursing loans. This calls for a process that ensures easy loan disbursement and protects the lender from potential loss.

Credit control offers strategies and practices that help individuals and institutions manage lending and borrowing wisely. This article will delve into the meaning and types of credit control, offering insights into how it influences our daily financial decisions.

What is Credit Control? (Meaning & Definition)

In financial jargon, the definition of credit control includes practices used by lending institutions and financers to regulate the risk associated with providing credit to potential borrowers. The main goal of credit control is to ensure that loans and credit are granted to individuals or businesses likely to repay them promptly and responsibly while reducing the risk of defaults and financial losses.

Credit control involves various measures to secure loans, including assessing the creditworthiness of borrowers, setting credit limits, establishing interest rates and terms of repayment, and using collateral. These measures help lenders make informed decisions about the creditworthiness of individuals or businesses in different circumstances.

An effective credit control system is essential for lending institutions to maintain financial stability, ensure profitability, and encourage healthy borrowing and lending practices. It also helps prevent excessive debt accumulation and economic crises. The Reserve Bank of India (RBI) controls ready assets and financing.

How Credit Control Works?

The basic premise behind credit control is making funds readily available to the borrower whilst ensuring that the borrowed amount is repaid in time. Giving customers credit makes it easier to take care of their needs immediately. Additionally, repaying the amount in smaller instalments simplifies the loan repayment process. A certain percentage is charged as interest, where the lending institution makes a profit.

To maintain the sustainability of this process, lending institutions use strategies to minimise the risk of defaults. Establishing borrowing limits, conducting credit assessments, and continuous monitoring are proven approaches for managing credit effectively. The key is to make payments extremely easy for the borrower to ignore.

5 Different Types of Credit Control

1. Credit Assessment

This involves evaluating the borrower’s financial health, history of credit, and repayment capacity. This helps lending institutions make better decisions about providing credit only to responsible borrowers.

2. Credit Terms and Conditions:

These act as a general guideline to the borrowing terms, establishing interest rates, repayment schedule, and collateral (if applicable). The terms and conditions are meant to clarify and should be studied carefully before applying for a loan.

3. Credit Monitoring and Reporting:

This is where credit assessment from institutions like CIBIL comes in handy. Lenders can track a potential borrower’s financial status and habits by requesting a detailed credit history analysis. Credit scores and ranks are valuable inputs for determining risk.

4. Debt Collection:

These include collecting unpaid loans and reducing potential loss. Maintaining consistent communication, setting clear expectations, focusing on overdue bills, and adopting automation can help recover loans ethically.

5. Credit Insurance:

The insurance is a security to lenders when the borrower defaults on their payments.

Factors Affecting Credit Control

Here are the major factors that significantly affect credit control:

1. Economic Environment:

Factors affecting financial stability, such as unemployment, inflation, and interest rates, can affect the repayment capacity.

2. Industry Trends:

Different industries have different credit risk profiles. These may vary for cyclical sectors, such as construction and manufacturing, and non-cyclical industries, such as healthcare and consumer staples.

3. Creditworthiness:

Creditworthy customers are considered more responsible and are likely to repay their debts.

4. Credit terms:

Businesses that offer extended payment terms or high credit limits are likelier to experience lousy debt than businesses that provide shorter or lower credit limits.

5. Credit control policies and procedures:

Effective credit control policies can help businesses decrease the risk of bad debt and improve cash flow.

6. Market Competition:

Customers may gravitate towards rival lenders' policies that look more promising.

Importance of Credit Control

Credit control serves a variety of interests in personal and business finance:

1. Mitigates risk: Credit control helps manage the risks of lending money to individuals or businesses who may default on their payments, thus reducing potential financial losses.

2. Provides financial stability: Using effective strategies for debt collection can ensure timely loan repayments, thus preventing disruptions in cash flow.

3. Profitability: When sustained properly, credit control brings in profits for lenders, as it minimises defaults and losses.

4. Responsible Borrowing: Credit control encourages responsible borrowing and deterring poor financial practices by assessing the creditworthiness of borrowers.

5. Economic Safeguard: Credit control practices prevent excessive debt accumulation and financial crises.

6. Regulatory Compliance: Lenders and financial institutions adhere to regulations, making credit control essential for legal and ethical compliance.

7. Consumer Protection: Adhering to responsible credit control practices protects borrowers from excessive borrowing and ensures fair lending practices.

Essential Steps of a Credit Control Process

To ensure a disciplined collection mechanism, credit control procedures should be efficient and repeatable. Both borrowers and lenders must clearly understand these steps:

Step 1: Gather precise customer details, such as KYC details, business information (if applicable), address, and contact information.

Step 2: Perform a thorough check by evaluating credit score checks and credit history to assess the borrower’s financial reliability and history.

Step 3: Establishing credit limits to mitigate the chances of risk.

Step 4: Maintaining a seamless reviewing process that includes checking for overdue and unpaid invoices, contacting customers with outstanding dues, and addressing invoice disputes.

Step 5: Collaborating with customers to negotiate repayment plans that facilitate easier repayment. Clear communication is the key.

Lending institutions should generally provide flexible payment methods, incentivise early payments, and modify credit terms to ensure customer satisfaction.

Conclusion

In the world of lending and borrowing, credit control is the compass that helps maintain fair and timely financial transactions. Understanding credit control is crucial whether you're an individual seeking a loan or a lending institution extending credit to customers.

It protects against defaults, supports economic stability, and encourages responsible financial behaviour. Clear and consistent communication, robust due diligence, and simpler payment options are the keys to making credit control a reliable process.