9 steps towards an effective credit policy

May 19, 2022


Estimated reading time: 6 minutes

Various strategies are available to protect your company’s cash flow against late payments. One of these is the company’s credit policy.

Your credit policy is an essential ingredient in risk management and will protect your business from customers who are unable to meet their payment obligations.

The truth is, however, that not all companies have these credit policies in writing. Seasoned credit managers and credit controllers may have a sense of the risk their company wishes to run and be able to estimate how far they can go on an account-by-account basis. For new employees, it is a different story – so there should be no grey area that can lead to misunderstandings.

What is a credit policy?

First of all, let’s consider what a credit policy exactly entails. In fact, it is a set of rules and procedures that defines the credit and payment conditions for your customers. By putting this in place, you create a firm foundation for your employees, and you can take a clear stance in the event of late payments.

By drawing up a formal credit policy, you will be better able to defend yourself against non-payment. This is a must, especially for industries and sectors that have a reputation for slow or partial payments.

With a credit policy, you can, for example, allow customers to divide very large invoices into partial payments. These smaller instalments make it easier for your customer to pay, while each instalment contributes to your company’s cashflow.

The credit policy is at the forefront of the sales process. To put it bluntly: as soon as you invoice a customer for products or services, or start working before payment has been received, you are actually working on credit.

Credit policies differ enormously between companies. And although a credit policy is very common in the largest companies, it is rather the exception in smaller companies.

Why have a credit policy?

There are several reasons why, as a company, you should think carefully about your credit policy and put it in an official document. Everything revolves around the degree of risk you as a company wish to run with your customers. Maximising turnover while minimising risk is what it’s all about.

Most companies, it should be said, do not work on credit but immediately send an invoice with an order. It goes without saying that enforcing a credit policy has a lower priority for such companies.

A few reasons why a credit policy is necessary:

  • It ensures a consistent approach. Everyone in the company knows the credit conditions and which of these are available for which types of customers.
  • It increases efficiency considerably. Employees know what is going on and they don’t need to ask colleagues for permission or advice. Even when new employees join the company, they are immediately informed. The credit policy is then a standard part of the training material.
  • With a good credit policy, you actually set out your expectations before the sales agreement is concluded. When the invoice is sent out, the other party knows what is going to happen, even if payment is late. In this case, you also have the necessary leverage should legal proceedings arise.

How do you draw up an effective credit policy?

When writing a credit policy, many factors can have an influence. An effective credit policy consists of at least the following components:

1. What are your goals?

Set a realistic goal. Often this is a clear and measurable target, such as reducing DSO by a certain percentage. But it can also be a smaller target where you always approve credit requests below a certain, smaller amount.

2. People and responsibilities

Make sure you have the necessary people and resources to implement your credit policy. With software and built-in automation, you can make this process as efficient as possible. Clearly define the role and responsibilities of each team member. Determine when other departments in the company – outside the finance team – come into play. And see if there are efficiency improvements that can be made in that area.

3. Which customers are eligible for credit?

Screen your customers on their creditworthiness to determine your credit policy and to help you grant credit. For example, you can automatically notify your customer and determine which items must be included on the credit report. This request for information is necessary for the customer to be able to use your credit. Part of that information is, for instance, the age of the company and its credit score … At the end of the day, this will give you a certain risk score.

The amount of credit information you need to gather about a company is best related to the credit limit offered. If you are offering a relatively low amount and you know that the company’s credit reputation is good, you do not need to obtain any further credit information. Conversely, for high amounts or starting businesses, it is advisable to obtain more information.

4. Credit and terms of payment

Whenever you offer credit, you may be able to charge interest. You can also secure payment deadlines, the payment method, or offer discounts for early payments.

5. Communicating the maximum credit limit

Determine in advance what your maximum credit limit is across all credits, and what the maximum credit limit is for each type of customer. Allocating your credit to one large customer is risky and prevents other customers from benefiting from credit.

6. Clear documentation

Document the conditions and details around purchase orders, credit requests, invoices and contracts. Work with examples and specify when a particular document should be communicated to the customer.

7. Think carefully about debtor management

Describe the formal procedures and steps to deal with customers who do not pay on time, and how you will recover any outstanding amount. No credit policy can avoid the reality that there will always be customers who cannot pay.

Don’t be afraid to be strict with your customers. Do not hesitate to reduce the amount of credit extended to a customer or to shorten the payment period if this customer always pays too late. However, do not forget to inform the customer about this the next time they purchase your product or service. Do the same internally with the sales department.

8. Take your time

The ideal credit policy for your company cannot be determined in an instant. It often involves a lot of trial and error. It takes a while before you can make a good estimate of which companies carry a high credit risk and which do not.

With the right software and integrations, you can eliminate a lot of this guesswork. Scores from trade information partners and your own data are then automatically calculated and combined to arrive at a credit score.

9. Evaluate on a regular basis

The fact is, credit policies are dynamic. It changes over time with the growth of your business, entry into new markets, economic conditions in each country, and so on. Regular review is recommended so that the credit policy continues to meet the needs of your business.

Credit policy as a stable factor

A clear credit policy is a must for any business. By explicitly documenting processes and procedures, a credit policy ensures a consistent approach to your customers and, in the long run, a stable and predictable cashflow.

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