My friend Mike Selfridge at Silicon Valley Bank has this great post in CFO Magazine:
The CFOs I know don’t typically think of themselves as bankers, but a walk in wingtips would serve them well. Paramount to a bank’s success is the chief credit officer, responsible for the institution’s credit portfolio, lending practices, and overall risk management. Successful policies established by the chief credit officer lead to a strong financial foundation, which in turn spurs future growth.
In many regards, the CFO position is akin to that of the chief credit officer. Both extend credit to clients, implement strong policies and procedures, and ensure that the extension of credit supports the firm’s overall strategy for growth — without compromising its financial condition. CFOs can thus borrow from the chief credit officer’s playbook when establishing an effective credit policy and process, or when fortifying an existing one.
The objective of a good credit policy is to establish approval authorities, define the guidelines, outline responsibilities, and specify the lending practices that will be employed when extending credit to customers. Policy objectives cannot be accomplished, however, without an emphasis on credit quality, which is enhanced by a thorough knowledge of clients and their businesses, as well as a thoughtful evaluation of risk, supported by proper documentation.
By using industry benchmarks, a credit policy can provide stated goals for such credit metrics as days sales outstanding, bad debt expense ratios, and the allowance for doubtful accounts. For banks, net charge-offs are the equivalent of bad debt expense, and a net charge-off ratio of less than 0.75% of average loans is considered acceptable by most commercial lending institutions. Less than 0.50% would be strong. For corporations, depending upon the industry and its typical gross margins, a bad debt expense ratio of less than 0.25% would be acceptable.