The following is a guest post by Daniela MckVicker, a blogger for Top Writers Review.
Considering offering credit to your customers? A credit policy is a document that you need. It outlines the conditions of credit sales, giving your customers one more way to make orders. For your business, it helps encourage new sales and manage associated risks.
If you need help with writing a business credit policy, consider these guidelines.
What Is a Credit Policy?
A credit policy is a document that defines credit and payment terms for customers and policies to mitigate risk from extending credit to those who can’t meet their obligations. These guidelines are critical for businesses selling their products and services in credit.
When broken down into essential parts, a credit policy includes:
- Evaluation of a customer’s creditworthiness
- Decision process to extend credit to customers (terms, conditions, etc.)
- Credit limits for customers
- Methods of dealing with delinquent accounts
A sound credit policy minimizes the risk of not receiving funds from sales made on credit. So, writing this policy requires knowledge of a company’s financial capabilities, applicable laws, and risks involved.
Before Writing: Credit Policy Do’s and Don’ts
If you’re writing a new draft or updating the current credit policy, keep these tips in mind:
- Don’t keep it confidential. Everyone in your company should know how you’re going to manage credit sales.
- Don’t make the policy so strict, so you have opportunities to adjust the credit decision-making process later.
- Don’t make the policy too broad and/or open to interpretation. This might cause conflicting interpretations by department members or other stakeholders.
- Do make credit approval limits clear for those with authority to grant credits.
- Do include procedures to reduce credit risks and sales where customers are unable to pay off the debt.
- Do include guidelines on keeping company and customer information private.
- Do state that any unlawful or unethical behavior within the credit department is strictly prohibited.
How to Write an Effective Business Credit Policy
Let’s go over each important section in business credit policies.
1. Explain the Purpose of the Policy
The first section of a business’s credit policy is dedicated to the conditions, responsibilities, and rights of the credit department. Describe how it works and helps to meet the goals you’re trying to achieve as an organization.
“The credit department is responsible for establishing payment terms for the company’s customers and monitoring these terms to ensure compliance. The present credit policy describes alternative payment methods to customers.”
Treat this section as an introduction that you’ll later use to teach employees. Save the specifics for the subsequent parts – there’s plenty of space for that.
2. List the Roles and Responsibilities of Credit Department Members
Explain the duties of each member who works in the credit department. By doing so, you’re defining their roles and letting them know what’s expected of them.
Here are some common credit department positions, along with brief descriptions:
- Chief Financial Officer (CFO). Responsible for managing the entire department, making policies and finance-related decisions
- Credit manager. Organizes and controls the credit department by training personnel, setting up credit rules and procedures, and authorizing credit limits. Reports directly to CFO
- Collections manager. Manages the credit collection effort by collaborating with third-party collection agencies. Reports to the credit manager
- Credit analyst. Reviews financials, evaluates and assigns credit lines for customers
- Billing clerk. Prepares the invoices and sends them to customers in time.
3. Describe Credit Application Process
The credit application process is the process that leads to the initiation or extension of credit to a customer. In this section, the main purpose is to explain this process and the procedure of approval.
To apply for credit, customers must also provide a number of documents. Commonly, companies request credit bureau reports, credit references, financial statements, and public records.
Some of the most important points to provide in this section:
- Description of conditions on which a customer can apply for credit
- Documents the customer must provide to get their application reviewed (bank references, statement of payment terms, etc.)
- Identification of credit department employees responsible for reviewing customer applications
- Description of the customer’s creditworthiness evaluation and relevant credit limits.
4. Decide Who Can Get Extended Credit
Obviously, your business can’t give away credits like Christmas cookies. In some cases, customers will have histories of not delivering on their obligations–so your policy should call for credit checks on every applicant.
In addition to asking customers to provide relevant documents, have your credit department also get in touch with nationwide credit reporting agencies. The three main credit bureaus are Equifax, Experian, and TransUnion, which can provide a free credit report once every 12 months.
Advise your customers on how and when to talk to a credit reporting agency about their reports. Keep in mind, however, that you’re legally required to ask customers for permission before making a credit report inquiry.
5. Set Credit Limits
The credit policy defines the credit limit for your business. In other words, it gives your employees instructions on the amount to give and when to stop extending credit. Following these guidelines will help to reduce many risks.
For small businesses, a $5,000 credit limit is reasonable. This amount could reach up to $10,000 for a mid-sized company. However, the right amount for your business depends on two things: a customer’s credit history and your liabilities.
First, take a good look at a customer’s documents (income, debts, etc.) to determine the limit they could realistically handle. Second, ask yourself if you could still pay your own liabilities if that customer failed to pay credit on time. If the answer is “no,” then reducing the credit limit should be a good idea. Make sure to include these credit limits in your policy.
6. Define Terms and Conditions of Credit Sales
These are the terms and conditions for delivering products or services on credit. They’re essential for credit applications, sales contracts, emails, orders, and invoices–all sales-related documents.
They protect your rights by setting credit limits, customer responsibilities, and other important points. For example, describe when you will begin charging interest, extension conditions, interest rate, late payment fees, early payment discounts, and deposit requirements.
7. Plan for Handling Past Due Accounts
Unfortunately, even with your best effort to manage credit risks, some customers won’t pay collections on time. That’s why you need to have a plan for pursuing unpaid debts.
In most cases, credit policies instruct to send urgent payment reminders. Consider using debt collection agencies if a customer doesn’t pay after getting notified multiple times. Should that customer fail to meet their obligations on more than one sale, close their account.
8. Make Changes
A credit policy should be “a living document.” To evaluate if their credit department helps to meet business goals, companies have to measure its performance. This is where specific goals based on the company’s strategy come in.
For example, the credit department might be tasked with reducing the average number of days it takes to collect on credit sales by 20%. Comparing credit sales data for a defined period defines if the credit department met this goal.
The effectiveness of credit department efforts measured by goals defines changes to be made in the policy. If the department struggles to meet the goals, consider making appropriate changes to the document.
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