How to make an effective Credit Policy
What is a Credit Policy?
A credit policy is a set of rules that businesses and organisations use to manage the extension of credit to customers and clients. A credit policy is put in place to minimise financial risks and ensure a healthy and stable cash flow for your business or organisation.
They are an essential piece of documentation to help you with the effectiveness of your Credit Management. If you supply to your customers on credit terms then making sure you have an effective credit policy in place is a smart move. By setting out the guidelines and procedures governing the organisation’s approach to credit sales, a credit policy formally recognises the strategic importance of controlling financial risk and provides operational clarity to all areas within the business.
The exact contents of the policy will depend on the specific requirements of the business, but as a general guide it’s good practice to cover the following areas that will be covered in this blog.
What a Credit Policy should include
Credit Risk Assessments
Identifying credit risk and applying appropriate mitigation strategies helps minimise late payments and bad debts. The policy should explain who is responsible for carrying out risk assessments, how and when they are done and how the outcomes are communicated to the relevant business areas. By establishing authorisation and exception limits you set a clear point of reference for the level of risk the business is comfortable with.
The process of assessing customer risk greatly benefits from specialist know-how – it is important to know your customer and assess Credit Risk effectively.
Setting Credit Limits
The trusty credit limit is one of the best risk management tools you have at your disposal and the policy should go into some level detail about how they operate: how a limit is set, how often it is reviewed and where relevant, how the process of stopping supply works.
Payment terms & methods
It’s helpful to include your standard terms (or a link to where they can be accessed) and accepted methods of payment. Have these within your credit policy to act as a point of reference for all staff. This section should also include details regarding any early payment discounts or late payment penalties that are used. Similarly, if the business accepts any form of security in particular circumstances, such as personal guarantees, the relevant procedures for use can be included here.
Monitoring and Collections Processes
An essential part of effective Credit Management is monitoring customer payments and following up in a timely manner.
This section of the policy should set out the standard procedures to follow, including the frequency and communication methods used. It is important to clearly define who has authority to remove a particular customer from the standard collections process and who can approve a bad debt write off.
The policy should outline what the trigger points for escalation are, and the circumstances under which external resources (e.g. instructing solicitors) can be used.
Consider including a query resolution process which defines who is responsible for resolving issues that are preventing payment. This should show timescales and internal escalation when required.
Account Handler contact details
In a larger organisation where a team of credit controllers are responsible for specific ledgers it is helpful to identify roles and responsibilities. Make sure this section is kept updated.
Regular Review
As with any strategic document it’s important to continually review and update your credit policy to meet changing market conditions and business requirements.
Key performance indicators that help measure the effectiveness of your credit policy include Days’ Sales Outstanding (DSO), Days’ Delinquent, bad debt ratios, query resolution and customer satisfaction.
Summary
Creating an effective credit policy and making it available to all staff is a great way to emphasise the strategic importance the business places on managing financial risk. Having a best practice reference point encourages consistency and sets up your business to reap the benefits of extending credit to your customer base.