Before you extend credit to clients, customers, and other people and organizations you do business with, you should have a business credit policy in place. The requirements and terms you establish before you extend credit are an integral part of setting up your business for financial success. In this guide, find out everything your credit policy should include and why such policies are so important.
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A credit policy is a set of terms that lays out how your company will issue credit to its clients and collect unpaid debts. It also specifies which team members in your company have the authority to grant credit or change the terms of credit.
A business that’s just starting out may get away with not having a formal credit policy for a time, especially if it only bills very dependable payers. If a business extends a great deal of credit, however, or if customers turn out to be less dependable, having a good credit policy in place can mean the difference between prosperity and financial hardship.
There are many reasons a good credit policy protects your business:
The policy document is used internally by your business; it’s not usually seen by customers and the public. Your staff uses the information in the credit policy to create credit agreements for clients and customers. You can also use some of the information, such as minimum credit scores or interest rates, in promotional materials for clients.
Not every company chooses to offer credit, but many B2B companies benefit from doing so.
A credit policy is an internal document your business uses to determine which clients you give credit to, the terms of credit and how your business collects unpaid debts.
To develop a credit policy, write a formal document with the following sections:
The top of the credit policy should state that the document is your company credit policy. This purpose statement can be brief; two or three sentences should do.
Next, state the types of clients and sales your credit policy governs. For example, some credit policies apply only to domestic sales made to businesses of a certain size, whereas others pertain only to international clients.
Perhaps the most important part of your credit policy is the section on credit terms. Be sure to specify the following information:
Your credit policy should detail how your company processes credit applications and reviews the credit history of established creditors. Include any factors that could result in a lower credit line. Similarly, note any changes to established customer accounts that could affect credit standing.
Your sales team may want some flexibility to make credit terms work for specific customers. Include text that empowers your team members to modify terms to maximize sales while still protecting the company’s cash flow.
End your credit policy with a statement of who on your team can execute certain credit-related tasks. This way, both you and your debtors are clear on which employees they can contact or expect to hear from on credit-related matters. Without mutual clarity on these terms, you might find that unauthorized people on your team have extended credit to unqualified clients. Retracting this credit will be challenging, if not impossible.
Your finished credit policy should spell out these details:
You should run credit checks on clients, with their permission, before you offer them credit. A credit policy should state the minimum requirements for clients to receive credit with your best terms. Less-qualified clients may be approved for lower credit limits or with less-favorable terms. Clients with poor credit histories are generally excluded from receiving credit unless the debt is secured.
The amount of credit you can extend generally depends on the amount of risk you’re willing to take on any given customer and how much total credit you can afford to extend without damaging your own cash flow. For example, if you expect to extend credit to up to 20 customers at once, plan to set credit limits for each customer so you’re not in danger of hurting your own cash flow.
In addition, avoid extending too much credit for clients to pay back. As they make payments regularly and prove to be reliable, you can increase their credit limits.
When businesses offer credit for more than 30 days, they generally charge interest on the balance. Include any interest rates in your policy. Also list payment deadlines, acceptable payment methods (such as credit cards and personal checks), early-payment discounts, and late-payment or over-limit fees.
In your credit policy, state the types of information clients must provide in order to receive credit. Depending on the type of customer and other factors, this information may include how long they’ve been in business, the goods and services they expect to receive on credit, financial statements and credit scores.
Establishing invoicing practices goes hand in hand with setting a credit policy. Any company (or freelancer) that invoices clients to receive payment for work already done is operating on a credit model. [Learn how to create an invoice and how freelancers can collect unpaid debt.]
No credit policy, no matter how comprehensive, can guarantee you’ll receive what’s owed. Some customers still won’t pay their bills regardless. That’s why good credit policies 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.
A credit policy is not the same as a credit agreement. A credit policy is a document used within the company that governs how you extend credit. A credit agreement, by contrast, is a document signed by the person to whom you are extending credit, where they agree to the terms.
If you follow the structure detailed above and include the components we highlighted, your credit policy might end up looking something like this:
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 deemed lower than the minimum if credit reports show low credit scores, credit histories of less than five years or ratios below 1:1. Likewise, the credit department may need to modify the credit limit of a current account.
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 to speak with clients about their credit status. The remainder of the credit team will contact clients solely to provide instructions for paying their debts.
Operating a company without a credit policy is inherently risky. That’s because businesses without formal credit policies may unwittingly extend credit to clients who are unable to pay as promised or have track records of not meeting financial obligations. Without clear rules in place, you may fail to bind clients to timely payments, and fewer payments mean reduced cash flow. Less cash flow results in more challenges in paying your own bills and keeping operations profitable.
More pointedly, following standardized credit policies can help you keep clients accountable if you work in an industry known for slow or partial client payments. The mere institution of a credit policy at your company can help your team follow processes that make you more likely to be paid.
Credit policies also decrease the likelihood of unpaid debts because they make it possible for you to set up payment plans for clients who need to pay large invoices. It’s far better to get paid in regular, predictable payments than not at all. In short, credit policies are good for you and your clients. [Read related article: Quote vs. Invoice: What’s the Difference?]
Credit policies are important because they help you avoid extending credit to clients who are unlikely to pay, while keeping clients accountable and increasing cash flow.
A business credit policy should be implemented before you begin to extend credit. Every team member at your company who deals with credit should understand this policy and refer to it.
You should also refer to this internal document when creating external communications, including sales promotions and credit contracts with customers and clients. With your new policy in place, you and your team can make consistent decisions that benefit both your business and your customers and lead to consistent financial growth for years to come.
Sally Herigstad contributed to this article.