One of the significant elements of credit management is the assessment of the credit risk of the customer. As assessing risk two kind of errors arise that are as follows.
Type 1 error: Good customers are misclassified as compare to poor credit risk
Type 2 errors: Bad customers are misclassified as compare to the good credit risk.
Both types of the errors are costly. Type 1 error causes loss of profit on sales and also loss of good customers. And type II errors cause bad debts and other costs related with the bad debts. These types of errors can't be entirely removed but an exact credit evaluation process can reduce these two kinds of errors. The credit evaluation process includes the subsequent steps.
1) Credit information
2) Credit investigation
3) Credit limits
4) Collection policy.