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How to Develop a Credit Policy

Max Freedman
Max Freedman
Researcher

A credit policy can help protect you against clients who don't pay what they owe and boost your cash flow.

  • A credit policy determines which clients are eligible for credit from your company and outlines how you'll collect unpaid debts.
  • Credit policies are important because they keep your clients accountable and boost your cash flow.
  • Credit policies should detail your company's credit qualifications, credit limits and terms, and invoice and debt collection terms.
  • This article is for business owners interested in developing client credit policies and payment terms to minimize unpaid bills and avoid the collections process.

When you hear "business credit," you might think first of your company's loans and credit cards. However, your company can also create its own credit lines for your clients through a credit policy. These policies set up ways for clients to pay you for your work gradually instead of delaying payment and appearing delinquent. This way, clients can better afford your services and slowly pay you without giving the impression that they're neglecting their financial obligations to you.

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What is a credit policy?

A credit policy is a set of terms that lays out how your company will issue credit to its clients and collect unpaid debts. Anytime you invoice a client for services and begin working before the client pays you, you're technically working on credit, even if you don't have a formal credit policy. A formal credit policy helps you protect yourself in the event of nonpayment.

A good credit policy achieves the following goals:

  • Qualifies and disqualifies certain clients for credit
  • Defines credit payment terms for qualified clients
  • Sets maximum credit limits
  • Outlines how your company will collect outstanding debts

Note that not every company chooses to offer credit, but many B2B companies benefit from doing so.

Key takeawayKey takeaway: A credit policy determines which clients you'll give credit to and how you'll collect unpaid debts.

The importance of credit policies for businesses

Without a credit policy, operating your company on an invoice-based billing model is inherently risky. That's because companies without credit policies have fewer contractual ways to bind clients to timely payments, and fewer payments mean reduced cash flow. With less cash flow comes more challenges in paying bills and keeping operations profitable.

More pointedly, credit policies keep clients accountable to you if you work in an industry known for slow or partial client payments. These policies leave little room for clients to argue against repaying their debts if you do ultimately send them to collections or file a lawsuit. The mere institution of a credit policy at your company can make it clear to clients that you won't let your work go unpaid.

Credit policies also decrease the likelihood of unpaid debts because they allow clients to pay large invoices in small installments. These installments make client payment easier – and they make your life easier too, since they bolster your cash flow. In short, credit policies are as good for you as for your clients.

TipTip: Credit policies are important because they keep clients accountable and increase your cash flow.

What should be included in a credit policy?

A credit policy should spell out these details:

  • Client qualifications for receiving credit. It's best to run credit checks on clients before you offer them credit, though you can only do so with the client's permission. Your credit policy should thus state what a client's credit report must look like for the client to qualify for credit. Clients with a poor borrowing history should be disqualified.

  • Credit limits. If offering $15,000 in credit to a client would give you far too little cash to pay your bills, then lower your credit limit. If you expect several customers to take credit from your company, figure out how your maximum credit limit can accommodate several borrowers while keeping your cash flow adequate.

  • Credit terms. Anytime you offer credit, you have the opportunity to earn interest. You should include interest rates in your policy alongside payment deadlines, acceptable payment methods (such as credit cards and personal checks), early payment discounts and late payment fees.

  • Requests for customer information. In your credit policy, state which types of information you'll need clients to provide in order to approve them for credit. Such information could include how long they have been in business (for B2B clients), the services they expect to need, and their credit score.

  • Invoicing terms. Firmly establishing your invoicing practices goes hand in hand with setting a credit policy. That's because any company (or freelancer) that invoices clients to receive payment for work already done is operating on a credit model. [Read related article: How to Create an Invoice]

  • Debt collection terms. No credit policy can entirely prevent some debtors from failing to pay what they owe you. That's why your credit policy should describe the actions you'll take in the event of an unpaid account. Such actions could include sending the debt to collections or suing the client in small claims court.

If you do go the collections route, consult our collection agency reviews to find the right agency for your needs.

Did you KnowDid you know? Your credit policy should explain your credit qualifications, limits, and terms as well as your invoice and debt collection terms.

How to write a credit policy

To write a credit policy, combine the following sections in a written document:

1. Purpose statement

The top of the credit policy should state that the document is your company's credit policy. This purpose statement can be brief – two or three sentences should do.

2. Statement of scope

Next, you should state the types of clients and sales your credit policy governs. For example, some credit policies only apply to domestic sales made to businesses of a certain size, whereas others pertain only to international clients.

3. Credit and payment terms

After your credit policy's initial two statements, you can get into its more important stipulations by stating your credit limit and detailing any interest and fees. Also, state how long clients have to repay invoices after they are issued. If necessary, include language about corporate, bank or personal guarantees.

4. Credit application and review

Your credit policy should detail how your company will process credit applications and review the credit history of established creditors. Mention any applicant factors that could result in credit lower than your maximum. Similarly, note any changes to established creditors' accounts that could affect their current credit.

5. Sales terms

After discussing how you will qualify creditors, include text that empowers your credit team to modify your sales terms. Mention that this flexibility exists to maximize sales outcomes, and restate the basic payment terms.

6. Statement of credit team roles

End your credit policy with a statement of who on your credit team can execute certain credit-related tasks. This way, both you and your debtors are clear on which of your employees they can contact or expect to hear from on credit-related matters. Without mutual clarity on these terms, you could find that other people on your team have extended credit to unqualified clients. Retracting this credit will be challenging, if not impossible.

TipTip: A credit policy should state your agreement's purpose, scope and terms.

Sample credit policy

Given the above criteria, a credit policy template might appear as follows:

This credit policy outlines the requirements for granting credit to qualifying clients of [your company] and monitoring this credit thereafter. It also details how credit for existing customers may be modified and who at [your company] can issue or modify credit. This policy is valid for all United States sales but excludes public sector clients.

[Your company] will offer credit of at most [dollar amount here] to qualified customers, with [interest rate here] applied to each payment. The [your company] credit department head can expand or contract this credit line and demand a personal, corporate, or bank guarantee from certain clients before issuing credits. All credit repayment terms are net 60 days.

The credit department will review new credit applications to approve clients and determine credit amounts. An applicant's credit level may be lower than the maximum if credit reports reveal low credit scores, credit histories of less than five years, or ratios below 1:1. Likewise, a current account with credit in its name may have its credit modified if credit department review determines this need.

All client terms of sale are standardized according to [your company]'s current sales programs and promotions. The credit department head will approve all modifications of the terms of these programs and promotions as needed to maximize sales outcomes. The sales terms for all clients are net 60 days.

The [your company] credit manager has sole authority to approve the issuing of credit to clients and speaking with clients about their credit status. The remainder of the credit team will contact clients solely to provide instructions for paying their debts.

Signed:
_________________________ [your signature, title and company name]
_________________________ [your client's signature, title and company name]

You should have your client sign and return this policy to you either before starting your work for them or upon sending your invoice. While credit policies are not required in order to keep clients accountable, as you can tell from the above language, they can vastly increase the chances that you'll get paid on time – and that means good business.

Image Credit: SARINYAPINNGAM / Getty Images
Max Freedman
Max Freedman
Business News Daily Contributing Writer
Max Freedman is a content writer who has written hundreds of articles about small business strategy and operations, with a focus on finance and HR topics. He's also published articles on payroll, small business funding, and content marketing. In addition to covering these business fundamentals, Max also writes about improving company culture, optimizing business social media pages, and choosing appropriate organizational structures for small businesses.