Offering credit is a great way to grow your business but it can be risky. Cover your business by implementing an effective credit policy.
To successfully and consistently deal with credit in your business, you should have a credit policy. A credit policy is essentially a set of rules to help you decide when to provide credit and who to provide credit to; a good policy will also outline the process for chasing payments and collecting debt. Keep in mind that a credit policy will not entirely eliminate the risk to your firm but it can assist you to effectively manage the risk.
A credit policy will essentially answer any questions concerning the provision of credit in your business. So when developing your policy, make sure it answers these questions.
- What are your objectives?
- What are the specific goals?
- How do you authorise credit?
- How will you evaluate the customer?
- What are your guidelines for setting credit limits?
- What are your standard terms?
- How will you monitor customer accounts?
- When will an account be placed on hold?
- What is your collections procedure?
What are your objectives?
Any credit policy should start with a mission statement to outline your objectives and the function of the policy. The statement should be broad and concise, as individual procedures will be covered in other sections. It can include objectives like:
- timely processing of credit applications
- setting appropriate credit limits
- clear and regular communication with customers
Also briefly outline the different roles involved in the credit process (for example, if you have a credit team) so your employees are aware of their responsibilities.
What are the specific goals?
Set some realistic goals for your credit policy. The key is to include goals which are understandable, simple to measure but aren't too easy. You want to make sure you set a time limit for the goal so you have a deadline but it is challenging enough so you actually have to try to reach it. For example, you may aim to have 90 percent of all accounts paid by the due date before the end of the financial year.
How do you authorise credit?
Define your authorisation procedure. Your credit policy should be clear on who can approve credit and for how much. The manager or business owner may like to have approval of all credit accounts over a certain amount. While this is a good idea in theory, it is better to have a staggered approval process so the business owner does not become bogged down with applications. Also be careful not to make the process sluggish by slowing it down with too many authorisers.
How will you evaluate the customer?
Outline which sources you will use for credit assessment of new customers. This may differ according to whether you feel the customer will be a higher risk or request a higher credit limit - to do this it is good idea to identify customers as low, moderate or high risk. The procedure should be set out in the credit policy so each customer is treated consistently, regards of the employee they deal with.
Your process may differ but for an effective credit policy, each customer should be assessed using a credit report which includes identification details, payment history, trade data and financial stability.
You can order a company credit report from Dun & Bradstreet. Visit www.dnb.com.au/express for more information.
What are your guidelines for setting credit limits?
Each customer may require an individual credit limit depending on their ability to repay or pay on time. You can establish this from the credit report as part of your evaluation and using your customer identification system (low, moderate or high risk). Financial and trade data will be most useful.
You credit limits should always be a little flexible as things change over time however, be sure to apply the most flexible credit limits to your low risk customers and tighter limits on the moderate risk customers. It is not advisable to approve a trading relationship with high risk customers.
What are your standard terms?
Set payment terms. You should have standard terms across your business as this will reduce confusion for your accounts receivable team. Ideally, before you provide credit, your customers should sign a credit agreement which clearly states your chosen terms. Also, each invoice should prominently feature your terms so there will not be any uncertainty with your customers down the track, particularly if their payment terms differ from your own. If you do have a customer with different payment terms, evaluate how valuable their business is to you or whether sticking to your own payment terms is more important.
How will you monitor customer accounts?
Be sure to regularly monitor your customers as it can help you identify a problem before it gets out of hand. The monitoring process should use the same sources and procedure as your evaluation process. Customers should be reassessed at regular intervals, particularly very active accounts however if this task is too daunting, ensure you at least evaluate the critical customers once a year.
Also consider a credit reporting agency which offers an alerts service to assist in identifying increasing risk with your key customers. Visit www.dnb.com.au for more information about Dun & Bradstreet's alerts service.
When will an account be placed on hold?
You credit policy should clearly state at what time an account should be put on hold. Common practice is to hold orders if their invoice is more than seven days overdue or cease extending credit once customers have exceed their credit limit by 10%. However, this particular policy depends on your individual circumstances and market conditions.
What is your collections procedure?
Your collections procedure is of utmost importance to the credit policy. Once a customer is beyond a particular period overdue, you need to implement your collections policy. This can include letters, phone calls and eventually a debt collection agency. Again, your policy depends on individual circumstances and preferences however the best collection procedures are proactive and uniform.
For more information on how to collect outstanding accounts read Its time to get tough on late payment >>
Dun & Bradstreet also provides debt collection services. Visit www.dnb.com.au.
Take your time when it comes to developing your credit policy so you are satisfied with your guidelines. Ideally, you should reassess your policy annually so you can identify any issues and areas for improvement.