How to Design Credit Policies
This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.
When designing your company's credit policies, focus on supporting your company's goals. Most likely, you'll want to increase sales, market share, and profits. First, figure out the route you'll take on the road to higher sales, greater market share, and increased profitability. Next, describe new policies or updates to existing policies that can help achieve these goals.
Goal Achievement through Policy Design
These are examples of goals and how to achieve them through your credit policies.
1. Increase sales per customer.
Expand your payment options: accept charge cards in addition to cash. Start offering credit lines to customers if you haven't extended credit before. Or, if you've provided credit terms for years, increase credit lines for promptly paying customers.
2. Expand the base of customers.
Streamline your new account application or approval processes.
3. Speed up cash flow.
Reduce terms from 45 days to 30 days. Initiate customer calls before invoice due dates to verify satisfaction with your company's products or services and encourage prompt payment.
4. Start an ecommerce business in addition to running brick-and-mortar retail stores.
Set up systems to accept charge card and PayPal payments for ecommerce customers.
5. Pursue new types of customers, such as government agencies, major corporate accounts, and educational institutions.
Structure policies that are aligned with the processes and requirements of newly acquired key accounts.
6. Reduce bad debt.
Elevate the standard to qualify for credit terms. Require a deposit (or larger-than-previous deposit) prior to starting a new project.
Outside Forces that Impact Policy Effectiveness
Don't create policies without considering what's going on in the world. Be mindful of industry standards and economic conditions that may impact the effectiveness of your credit policies.
Consider the credit practices for your industry, business type, distribution channels, and customer profiles. Your company doesn't have to adhere to all standards but you should be aware of how your policies deviate from the norm. If your policies are more lenient, then you may attract new accounts quickly, including less desirable customers; if your policies are stricter, then you may incur fewer bad debts but forgo opportunities to nurture relationships with fast-growing companies.
Changing economic conditions, particularly more stringent rules of banks, can increase the credit needs of customers. So, to generate the same amount of sales as last year, your company might need to extend due dates or, if you've always required cash or cashier's check, begin accepting charge cards. Alternatively, to boost profits after a year with excessive bad debt, your business might start requiring larger deposits before accepting a project.
Practical Aspects of Policy Design
Credit policies should be complete as well as easy to understand, communicate, and enforce. Make sure you specify the following:
- credit terms or when payment is due relative to product and service delivery, such as within 30 days of order fulfillment;
- forms of payments accepted, such as personal or business check, cashiers' check, cash, charge card, and PayPal;
- methods of setting, communicating, and controlling credit lines;
- nature and extent of customer information required to set up a credit account, such as personal and business financial statements for commercial accounts; or driver's license number for consumer credit;
- incentives for early or on-time payment, such as discounts off invoice amounts;
- penalties for late payments, such as late charges or credit holds on orders;
- procedures for dealing with past due accounts and slow paying customers.
In addition, you should define and assign responsibilities to specific roles (e.g., credit manager establishes credit lines and credit analysts monitor use of these credit lines).
Access to credit policies shouldn't be the domain of your CFO or the credit department only. Nearly everyone in your company will need to know them: sales representatives, so that they will pursue the right types of accounts; customer service, so they'll make inventory commitments for credit-approved customers only; distribution, so they won't ship product to customers who have past due accounts; billing, so that they will create invoices that reflect credit agreements.
Create, implement, and update procedures for credit-related activities (new account set-up, billing, payment processing, collections, etc.) to match day-to-day activities with policies. And, establish procedures for dealing with problems, unusual requests, and exceptions.
Real-life Solutions via Policy Design
A friend and colleague who is the credit manager of a global corporation told me about new policies and procedures that allowed him to speed up cash flow and reduce operating costs.
To deal with unreliable mail delivery within certain regions in Mexico, my friend created country-specific policies and procedures. He consolidated invoices for multiple subsidiaries so that his credit analysts could more efficiently make face-to-face visits to collect payments. As a result, his company improved credit performance while honoring local traditions.
To institute online billing and payment, he designed policies using a tiered approach. Major customers were encouraged but not forced to adopt the system. However, all new accounts were set up to accept electronic invoices, and low-volume accounts were required to convert from paper-based to online methods.
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