Cash flow is the life line of any business so it’s no surprise that manufacturers regularly conduct credit and financial risk analysis on their distributors to ensure that they maintain healthy cash flows.

However, what manufacturers often are not doing is expanding this analysis to cover credit extensions that would be beneficial to situations such as new product introductions, ad hoc promotions and other special events that could drive sales spike across channels. This kind of limited foresight can be a constraint to both the manufacturer and the distributor in the long run, as it can often create a random ‘credit crunch’ for the distributor. There is a need to consider how frequently credit analysis is conducted and reviewed by the manufacturer; and how often credit terms and elasticity can be modified to align to changing market dynamics and truly enable distributors and other channel partners to dynamically and smartly leverage credit to drive incremental consumer sales.

Typically, credit analysis includes the manual assessment of a variety of aging reports, but it does not use information like order blocks to derive geo wise distribution realignment, targeted go to market propositions and specific channel sales opportunities.

These situations could leverage a hybrid model to help manufacturers better analyse the credit limits they impose on their distributors. The rigor with which manufacturers assess distributors’ credit worthiness has a direct correlation with the cost and agility of their revenue cycle.

What is needed is a model that emphasizes a real-time, automated credit analysis of existing distributors. It should include the dynamic analysis of factors such as a distributor’s past performance, their existing credit worthiness and their future line extensions and growth plans. By adopting a model of this kind, manufacturers are able to more frequently re-align their distributor’s credit terms and enhance their credit elasticity, thereby driving stronger channel relationships, and improved profits.

Current solutions that are broadly available to finance teams have the capability to set credit limits and monitor credit performance based on factors like days overdue, external credit scores, internal average payment performance and sales variability. However, existing solutions only consider the performance factors of the distributor for analysis. In order to create a fuller picture that enables a more dynamic and accurate credit limit setting, the analysis solution needs to also take into consideration the growth and expansion plans of the manufacturer.

Dynamic and automated credit analytics

Dynamic and automated credit analytics involves three levels of analysis. The inputs for all the levels of analysis can be in terms of relative percentages and this will provide the means to assess distributors of all categories so as to ensure fairness and uniformity in the analysis.

The first level of analysis looks at the regular KPIs of a distributor. The input for this analysis can be obtained from any accounts receivable module of an ERP package, so should be readily available for most manufacturers. The conclusion of the first level is a credit worthiness rating of the distributor, say for example on a scale of 1 to 10. The kinds of inputs for this stage are detailed below.

The second level of analysis looks at the past performance of the distributor with respect to the manufacturers products. For example this could include:

  • Quarter on Quarter growth in sales of the distributor
  • Quarter on Quarter growth in sales of the distributor with respect to the manufacturers products
  • Investment by the distributor to promote the manufacturers products, for example any additional expenses for incremental sales
This level of analysis will then give the distributor a performance rating as demonstrated below.

The third level of analysis looks at the expansion plans of the manufacturer and the distributor and considers the following KPIs:

  • Plans for capacity expansion by the distributor
  • Plans for portfolio expansion by the distributor
  • Plans for capacity expansion by the manufacturer
  • Plans for portfolio expansion by the manufacturer
  • New product launches by the manufacturer
This level of analysis will then provide an expansion rating as demonstrated below:

The final analysis compiles all three levels of analysis and provides insights and suggestions as to where the manufacturer can and should modify the credit terms for specific distributors. The suggestions made by this solution can be in terms of extension or reduction in payment period or in terms of credit limit flexibility as a percentage.

Impact analysis of the different levels of dynamic and automated credit analytics

Once the final rating is obtained it can be used to categorize distributors for better assessment. The top performers in a particular time frame (say monthly or quarterly) can be provided with loyalty points or with offers that will boost the relationship between the manufacturer and the distributor.

By adopting a solution that analyses both the manufacturer and the distributor, the distributor is driven to pay on time and improve their credit score helping the manufacturer to reduce Days Sales Outstanding. It also helps to improve cash-flow forecasting and transaction expenses, as well as reduce losses due to bad debt and collection expense.

For distributors, it aids strategic thinking with regards to long term line and business expansion perspectives and provides greater impetus to pay on time for the goods purchased. With a good payment track record across the three levels of analysis, the distributor can also take advantage of the bigger credit limit and extended payment periods. Ultimately, the approach facilitates growth for both manufacturers and their distributors by means of portfolio and capacity expansion, meaning both parties will see a positive result from adopting an enhanced credit analysis solution.

By Santosh Kumar Padmanabhan and Subramanyam Venkataraman, Wipro Limited