A business’s credit policy is an essential guide for how the business manages credit risk. However, if you don’t document your policy clearly, different people may understand or apply it differently — which can lead to confusion, inconsistency, and even legal problems. Here are some tips for creating an effective credit policy for your business.

The purpose of a credit policy

A credit policy is a detailed description of a business’s credit management processes and procedures, from credit analysis, setting credit limits, managing your credit portfolio, to collection procedures. It defines a company’s requirements for establishing a customer’s line of credit, provides a dollar figure for the amount of credit you’re willing to extend, offers guidance for setting repayment terms, and establishes early-payment discounts and late-payment penalties. It also provides policies for when and how to initiate collection procedures.

It’s important that these credit policies be in writing to assist understanding and avoid confusion. Clear and thorough documentation helps to ensure that credit policies are applied consistently across departments to all customers. This helps prevent confusion, reduce credit risk, and avoid potential legal issues. A written policy also clearly states each department’s role in managing credit so that duplication of effort and friction among individuals and departments are minimized. In addition, written policies are helpful for new employees, so they can refer to them and quickly get up to speed.

Creating your policy

Start by assembling a credit policy team. The team should include members from various departments, such as financial services, sales, and marketing.

The first task in writing your credit policy should be to define the credit department’s mission and goals, which should align with the company’s overall mission and goals. For example, a business with a strong market position and concerned primarily with cash flow may have a mission that serves to limit risk exposure and be very prudent and conservative in extending credit. A young company trying to gain market share may have more liberal and lenient policies and be willing to build credit relationships with customers that have a more questionable credit history. Your goals should be specific and quantifiable, such as limit bad debt to X percent of sales or let no accounts receivables go beyond 90 days.

Your credit policy team should determine which department or individual is responsible for which tasks in the credit policy. In addition, you should put measures in place for ensuring accountability.

Things to include in the credit policy

A credit policy can be general or detailed, depending on company size, type of business, or other factors. At a minimum, it should provide:

  • Clear qualification criteria — The credit policy should outline the information your firm requires for the credit application (credit score, credit history, past delinquencies, references) to help you make a sound credit decision.
  • A statement of how you will set credit limits — Will all new customers have the same limits, or will you determine limits based on information on the application?
  • Credit terms — How will you set terms? Will there be late penalties, and how much? Will you offer discounts for early repayment?
  • Credit review/monitoring guidelines — How often will you review your credit accounts?
  • Specific procedures — How will you handle late payments and delinquent accounts, collection steps, and — as a last resort — litigation procedures?

Once your credit policy is created and written, it should be distributed to management, credit and financial personnel, sales and marketing, and other relevant staff. Emphasize the reasons for a credit policy and the importance of using it consistently when evaluating risk and extending credit to business customers. Your credit policy is a dynamic document that should be reviewed periodically and updated according to changes in the economic landscape, amendments to your company’s mission or goals, and any new problems or concerns that arise over time.

Need help managing your commercial credit risk? MSCCM financial experts can assist you. Contact us today.