What to consider when building your business’s credit policy

A credit policy is a must-have for any business that extends credit to customers. It outlines the process and criteria for evaluating credit risk, extending credit, and managing accounts receivable. A good credit policy is essential for minimising risk, improving cash flow, and establishing a professional image for your business. It sets expectations and helps build customer trust, giving you a competitive edge.

When creating your business’s credit policy, there are several important factors to consider. It’s essential to ensure that your policy is comprehensive and tailored to your business’s specific needs. For instance, you may want to utilise tools and resources like Soft Pull Solutions to ensure that your policy is effective and efficient.

Furthermore, read on to dig deeper into the things you need to consider when building your business’s credit policy.

1. Defining credit terms

Credit terms are the conditions under which a business extends credit to its customers. They could consist of payment due dates, discounts for early payment, and late payment fees. It’s essential to have a clear understanding of credit terms before extending credit to customers.

Several credit terms are commonly used in business, including:

• Net 30: The invoice must be paid within thirty calendar days of receipt by the customer.
• 2/10, Net 30: If payment is received within ten days, the customer will receive a 2% discount; otherwise, the full amount in the invoice must be paid within 30 days.
• Open Account: The customer can pay the invoice whenever they want, with no payment deadline.
• Cash In Advance: Before the goods or services are delivered, the customer must pay for them.

When defining credit terms, it’s crucial to be concise and clear to prevent misunderstandings between the business and the customer. The customer’s credit history, payment history, and current financial situation should all be considered. A company can lessen the risk of non-payment and increase its cash flow by considering these factors.

2. Determining credit limits

Credit limits are the maximum amount of credit a business is willing to extend to a customer. A company can avoid overextending credit to clients who can’t repay it by having clear and defined credit limits. Doing so allows a business to reduce financial risk while increasing overall financial stability.

That said, here are several key factors to consider when setting credit limits:

• Customer’s credit history: Make sure to assess a customer’s credit history before extending credit, as it can help to predict their ability to pay.
• Payment history: A customer’s payment history with your business can indicate their ability and willingness to pay.
• Financial stability: The customer’s current financial situation can impact their ability to pay, so consider this as well.
• Industry standards: It’s essential to consider the industry standards when setting credit limits, as this can help ensure your business remains competitive.

Credit limits also help businesses establish their credit policy by setting clear customer expectations. Customers are more likely to stick to the terms of their credit agreement if they know the credit limit from the outset.

3. The credit application and approval process

A company’s credit policy must include a process for credit applications and approvals. Before extending credit, it involves assessing a customer’s creditworthiness to ascertain their capacity to repay the debt. A credit application form is typically filled out by the customer, which is then reviewed and approved by the company.

That said, the following components should be present on a credit application form:

• Contact information: It should include the client’s name, postal address, contact number, and email address.
• Business information: The customer’s company name, physical location, and other pertinent details.
• Financial information: Information about the customer’s finances, including their sources of income, their outgoing costs, and any unpaid debts.
• Trade references: Contact details for the customer’s suppliers or other relevant trade references.
• Authorised signature: The customer’s signature indicates that the information on the form is correct and that they agree to the terms and conditions of the extended credit.

Furthermore, the approval process typically involves the following steps:

• Review of credit application form: The credit application form is reviewed to determine the customer’s creditworthiness.
• Credit check: A credit check assesses the customer’s credit history and financial stability.
• Reference check: The customer’s bank, character and trade references are checked to assess their payment history.
• Approval or denial of credit: The business will either approve or deny the customer’s credit application based on the information gathered.

The credit application should be complete and accurate, providing businesses with the information needed to make an informed decision.

4. The credit monitoring and collection procedures

Establishing credit monitoring and collection procedures will help you keep track of your customer’s payment behaviour and take action, if necessary, to ensure that you receive payment for the goods and services you provide. For instance, if a customer’s payment history is starting to deteriorate, you may decide to limit their credit limit or require advance payment.

The collection process typically involves the following steps:

• Communication with the customer: The first step in the collection process is to communicate with the customer to discuss the overdue debt, if there’s any.
• Reminder letters: If the customer doesn’t respond to the initial communication, a reminder letter is sent to remind them of their debt.
• Final demand: If the customer still doesn’t respond, a last demand letter is sent, giving them a deadline to pay the debt.
• Legal action: If the customer fails to pay the debt, the business may take legal action to recover the money owed.

By adhering to these procedures, businesses can minimise the risk and ensure their business’s and clients’ financial stability.

5. Compliance with laws and regulations

Building a credit policy for your business involves establishing guidelines and procedures and ensuring that your policy complies with relevant laws and regulations. Failure to comply with these regulations can result in severe consequences for your business.

One of the most important laws to be aware of is the Fair Credit Reporting Act (FCRA). This law regulates consumer credit information collection, dissemination, and use. It also gives consumers the right to access and dispute credit reports. Businesses must comply with the FCRA when conducting credit checks and using credit information for business purposes.

Another example is the Equal Credit Opportunity Act (ECOA), a United States law enacted on October 28, 1974, prohibiting discrimination in credit transactions based on race, colour, religion, national origin, sex, marital status, or age. Businesses must comply with the ECOA when making credit decisions and can’t use prohibited factors as a basis for denying credit.

Conclusion

A well-developed credit policy can help your business reduce risk and improve financial stability. By setting clear guidelines and procedures, companies can ensure that they make consistent and fair credit decisions while protecting themselves from financial losses.

09/02/2023