Extending credit - to the right people, under the right circumstances - can be a boon to your business. It is generally recognised that extending credit to your customers has the following benefits:
Increased sales - Customers enjoy being able to delay payment, encouraging them to buy more. For many industries, providing credit is, in fact, an important business norm.
Improved profitability - Higher sales mean a healthier bottom line.
New customers - Individuals who may not have purchased from you before may be enticed to try (and become a loyal customer) when an attractive credit plan is offered.
- Increased market share - If your credit policy offers more attractive terms for customers, they may be persuaded to buy from you rather than your competition, enhancing your market share position.
Once you have decided to extend credit the next question becomes who do you provide that credit to and how do you do it? Who is a good credit risk and who is a bad credit risk?
A credit policy helps you answer these questions. It is essentially the set of rules that you decide to follow in order to determine who you will provide credit to, how much credit your will provide and how you will monitor that credit once it has been provided.
The challenge is identifying the level at which you are providing credit to as many people as possible within a framework that results in bad debts that fit your risk appetite.
A tight credit policy is fine but just remember that if credit is central to business growth then excessively limiting the amount of credit you provide has an impact on business growth.
All of this means having a very clear idea of how extending credit will impact your business variables and what processes are necessary to ensure any changes are properly handled. Consider the following questions:
- Do you have the required cash flow?
- What is sufficient?
- Do you have a system in place for receivables?
- How will you assess a customer's ability to pay?
- What credit information organisation will you use to assist you?
- How will you collect accounts that become overdue?
- Is your product priced accurately to reflect the cost of granting credit (i.e. to protect your income)?
- What terms will you use in extending credit?
So in order to develop your credit policy what are the key questions you need to ask yourself? Here are some key questions:
- How much credit can you afford to extend?
- What will be the maximum credit you extend per customer?
- How long will you allow for payment?
- Will you offer early payment discounts - and what will be the penalty for late payment?
- What will you include on your credit application form?
- Who will be your credit contact? Who will it be within your customer's company?
By answering these questions you should be able to develop a clear and concise credit policy that sets out what type of firms you will provide credit to, how much credit you will provide, on what terms you will provide it (i.e. payment terms), whether early payment incentives will be offered, what information you require to make your final credit decision and who has ultimate responsibility for this process.