Steps to Build and Implement an Effective Credit Policy

28 January, 2022
5 min read
Terri Miller, Director of Business Operations
Linkedin profile

What you'll learn

  • Importance and benefits of building an effective credit policy
  • Ways to create an effective credit policy for your business
  • Dos and don’ts of an effective credit policy
Importance and Benefits of Building an Effective Credit Policy
Ways to Create an Effective Credit Policy for Your Business
Way Forward
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A strong accounts receivable management strategy starts with a solid credit policy. A credit policy is a set of guidelines that specifies credit limits and payment conditions for customers, along with a defined course of action in case of late payments. Creating an effective credit policy takes time, thinking, and effort to develop.

Before you provide credit, make sure you have a policy in place that makes it easy for clients to pay you. Ask yourself these three essential questions to get started with a credit policy:

  1. Which credit options do you want to provide?
  2. Who do you wish to give credit to?
  3. How much credit are you willing to extend?

The credit choices you provide will also be determined by the type of business you run and the customers you have. Make your decision by understanding the fundamental rules of credit policy, and forms of credit you’d like to extend. Sorting customers into different risk categories based on credit data (i.e. low, medium, high) is another simple way. The lesser the risk, the greater the credit, and vice versa.

Importance and Benefits of Building an Effective Credit Policy

Operating your business on an invoice-based billing approach without a credit policy is risky. Businesses without credit policies have fewer contractual ways to tie customers to timely payments, and fewer payments mean reduced cash flow.

Most importantly, credit policies hold customers accountable to you if you work in an industry where customer payments are slow and irregular. They have limited space to argue against repaying their debts under these policies.

Credit policies also reduce the likelihood of outstanding debts by allowing customers to pay large bills in small installments. These payments make it easy for customers to pay and improve your company’s cash flow.

Your credit policy forms the basis to protect your company if a client fails to pay on time or refuses to pay. A sound credit policy helps your business maximize income, reduces bad debts, and avoids the risks associated with extended credit.

Credit Tip

Ways to Create an Effective Credit Policy for Your Business

A credit policy document defines procedures and measures to guide customers to pay on time. It also enables the collection team to take necessary steps in case of delayed payments or non-payment. A well-detailed credit policy outlines and supports company objectives, specifies authorization levels, defines expectations and roles, and improves cross-functional cooperation. Follow these steps if you're considering drafting or updating your company's credit policy. In no time, you'll have a solid policy in place. These 7 steps will guide you to create an effective credit policy that works for your business.

1. Build a Purpose Statement

When you start creating a credit policy, the first step is to describe what the credit policy is supposed to achieve. Begin by defining credit transactions, conditions, obligations, and rights. The credit policy should state that it is your company's credit policy. This declaration of purpose should be brief, in not more than two to three paragraphs. You should also specify which types of customers and sales are covered by your credit policy. Some credit restrictions, for example, only apply to domestic sales to enterprises of a specific size, while others only apply to overseas customers. This purpose statement must briefly describe how a credit policy works and how it helps to accomplish your business goals.

2. Summarize Roles and Responsibilities of Credit Team

Next, you must explain the responsibilities of each credit department employee and authorize them to carry out specific credit-related tasks. It is crucial to ensure that you also set a process and hierarchy chart for changes to be made if required. When you have a hierarchy chart along with roles and responsibilities, it becomes easier for your customers to connect with relevant team members for credit-related queries or issues.

3. Define Credit Application Process

The credit application process starts when a sale is being discussed with the customer. The terms of credit, which include the amount, the credit period, limit, and other terms are discussed. This process could either mean the start of a credit relationship with the customer or the renewal of an existing one. The main goal of this section is to describe this process and the approval procedure. Your credit policy should specify how your business will process new credit applications and review the credit history of existing clients.

4. Decide on Who Gets Extended Credit

Businesses give credit to customers who have a history of paying on time and can provide financial evidence to demonstrate their creditworthiness. Before extending credit to any customer, conduct a thorough background check on them. Is the company or its owners personally accountable for any debts? Can you obtain credit references? These are some questions you must be able to answer before you decide on extending credit to them.

5. Set the Credit Amount

The total amount of credit that your business will offer should be determined by your credit policy. Credit conditions do not have to be the same for every customer. When deciding on credit limits, you can examine a customer’s paperwork (income, debts, etc.), with their consent. Some credit teams also use the concept of the 5 Cs of Credit while assessing a customer’s credit risk.
Credit 5C

6. Clearly State Credit Sales Terms and Conditions

Interest rates, as well as payment deadlines, should be included in the credit policy along with credit limits, customer obligations, and other crucial details to protect your rights. You can hold your customers accountable to the conditions that are stated and agreed upon once the order is placed. You must do this by ensuring that your usual credit terms and conditions are clearly specified in all pre-sale correspondence.
Credit Dos and Don’ts

7. Specify Debt Collection Conditions

Your credit policy should clearly state what you'll do if an account goes overdue. You may choose to send urgent payment reminders when a customer fails to pay. If a customer does not pay after being informed several times, consider contacting debt collection agencies.

Way Forward

In today’s uncertain atmosphere, creating a credit policy ensures that you have a certain level of protection when customers refuse to pay or are unable to do so. A strong policy is closely related to your company’s goals and the amount of risk you are willing to take. However, having a defined credit policy assures less uncertainty and speeds up credit decisions. Learn how you can get paid faster, lower DSO, reduce invoicing costs, and lower bad-debt write-offs with our eInvoicing & Collections App.
Would you like to try our free credit policy template?
Sample Credit Policy Template

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