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CREDIT POLICY
FOR YOUR ORGANIZATION
According to the Merriam-Webster dictionary, the word policy can be defined as a definite course
or method of action selected from among alternatives and in light of given conditions to guide and
determine present and future decisions. While most individuals appreciate the need for policies as
a workable set of regulations, it can carry some negativity when viewed from a customers
perspective. Customers may perceive policies as unnecessary roadblocks barring them from what
would appear to be basic rights or customer expectations. Despite this, there are a number of
reasons to have a written credit policy. This document defines those reasons, along with
establishing a mission, goals, and various other aspects of an organizations credit policy. This
document outlines the process of how an organization can create and implement a credit policy,
with the primary focus being payment in a timely manner while maintaining good customer
relationships.
When creating a credit policy, an organization should understand and develop the following:
process?
details?
9. Invoicing policy
10. Collections
12. Conclusion
Credit management starts with the sale and ends only when the full and final payment has been
realized. It is as important a part of the deal as closing the sale. Technically, a sale is considered a
sale only when money has been collected. Many companies place the responsibility solely on their
customers for any unpaid debts. Quite the contrary is true. It is often the lack of a clear credit policy
A Credit Policy should be a well-configured and consistent process that a company incorporates in
order to control the risk it assumes when extending net payment terms to its customers. It can be
very general or very customized; it really depends on the company extending the terms. Although,
why the content of the policy differs can be due to many factors such as your companys cash flow,
profit margin, how competitive the market or industry is, your location, your customers location,
production needs or the size of your company. Consider these issues regarding the creation of a
credit policy:
One of the most important reasons why a company should have a credit policy is to safeguard its
accounts receivable. In addition to that, a pre-set credit policy gives stability, efficiency and
It also involves limiting bad debts and improving cash flow. With outstanding receivables being a
The policy provides consistency among departments, laying down a common set of goals. It can
also help in defining each department's functions so that duplication of effort is avoided.
The policy also allows companies to have a consistent approach among customers, ensuring its
decision-making is more structured. Writing down and making the customer aware of the policy
reinforces its application, and also gives a sense of fairness among customers and strengthens
The mission of your credit department defines the risk averseness of the company in relation to
offering credit in light of the overall mission of the organization. For example, if the company is
striving to gain market share, it may have a rather liberal credit policy. On the contrary, a company
with a significant market share can choose to be more conservative in its credit approach.
There are a number of approaches that a company might take when establishing goals. A simple one
might be the establishment of a no new customers are to receive credit consideration for the first 3 to
5 orders policy, with the understanding that they may be converted to specific credit terms after such
time if warranted. However, this may be an unattractive policy to some customers and your company
will have to determine if incorporating such an approach is worth risking a potential sale. Another
approach includes defining a more objective, measurable strategy. Some of the factors to be
Defining your companys CEI (Collectible Effectiveness Index) the ability of your collections staff
approaches to consider as
established by senior
management possibly
constant revisions to credit policy. Again, like the overall credit policy of the company, the goals can
be generic or highly customized according to the needs and nature of the business
This section is perhaps the most critical component of the policy statement, as it establishes the
roles, responsibilities, authority and accountability of each individual who has involvement with
customer credit. This helps in avoiding duplication of efforts and strife among various departments.
In this context, the workflow may include the way customers/orders are analyzed, processed, and
collected. This entire cycle can become very complicated as the company grows. It is important to
identify the various to-dos and checkpoints across the sales cycle. For examples, who is
responsible for collecting the required documentation from the customer (signed purchase order and
credit sheet)? Who does the actual credit research? Who analyzes the results of the research? Who
determines the credit limits? Who then does the invoicing and the customer follow-up?
If the company sets up a good workflow, seldom should there be a situation where it all comes to a
halt. It is, however, still necessary to have a policy in place, because changes will happen and the
company should know what to do in that situation. For example, if a customer wants to significantly
increase its credit limit, how is the approval process handled and who is the ultimate authority to
approve it?
Properly assigning these tasks and holding the respective individual(s) accountable is essential in
This is another important part of the credit policy and again, the level of detail depends on the size of
the company and its overall credit philosophy. A generic policy for a larger organization may be as
follows:
The Credit Department of the company establishes credit limits for all its customers per the
limits based on rating agencies, credit references, financial statements, security, or other
The above approach does not list specific details within the policy; however, a smaller business can
have a different approach when it comes to evaluating their customers credit position. A general
The sales representative will obtain a credit application from each customer. This will contain
a bank reference and three trade references. After calling references, the credit department
will determine if a customer has demonstrated the ability to pay bills in a prompt manner. If so,
customer details?
Screening customers in a
thorough manner is an
important factor in a
necessary customer
details only makes the screening process simpler and efficient while minimizing the risks. It allows the
credit department to filter obvious bad debts from the rest. Overall, it contributes toward building
relationships with the right customers, reducing risk situations and limiting the companys credit
exposure. With detailed information about the customer, a business can assess the risk of providing
credit and also ensure that it has the information necessary in case its needed for a legal action to
pursue payment
This includes a clear understanding of when the bills are due. For businesses with a simple and
straightforward product line with a consistent set of terms, this is not a difficult issue to handle. For
situations like this, you may choose to have a generic policy for terms of sale. However, for other
companies, with many different product lines with a variety of terms and conditions, this may pose a
much larger problem. In this case, your company may want to establish individual policies within the
Receivables exist because most industries offer their customers payment terms rather than cash on
delivery. If a supplier refuses to abide by such industry practices, they may face loss of business and
a hit to their reputation; customers may switch to competitors offering more standard industry terms.
Therefore, it has become a general way of doing business in most industries. Common approaches
include terms such as - Net 10 (payment ten days after invoice date), Net 30 (payment 30 days after
invoice date), 1% 10 Net 30 (1% discount if payment received within ten days, otherwise, payment
Developing an Aging of Accounts Receivable form is a good way to identify any receivables beyond
the agreed-upon terms of sale and helps identify problem customers. Although many billing solutions
9. Invoicing Policy
Seeking payment from customers is a critical component of the credit management process. Not only
does it ensure a steady flow of cash payments (in an ideal world), but also helps in promoting healthy
relationships with the customers. In order to manage invoicing procedures and customer
clear process for handling disputes and delays. The following steps in invoicing may reduce delays or
problems:
Invoice quickly Submit an invoice at the earliest possible convenience, whether its done
electronically, via email or sent through the mail. Invoicing electronically, whether through third-
party e-Invoicing, an enterprise billing system or small business billing software, will typically allow
Ensure the invoice is accurate Inaccurate invoices may create confusion, delays in payment
and overall tension between the company and its customer. As indicated immediately above,
billing electronically will typically help a supplier organization get it right the first time and help
Provide invoice details The customer should be able to see within the invoice the product or
service the invoice covers, the quantity, the delivery time and place, the specific amount due,
Quickly resolve any exceptions When an invoice is not paid because of an error, its called an
exception. Its worth putting in place a process by which any exceptions can be handled quickly
with the correct details. The faster an exception is handled, the faster payment can be made.
It is important to regularly
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10. Collections
The entire credit policy boils down to collections. A well thought-out collections policy should include
processes for both the best-case scenario (the customer pays on time or early) as well as the worst-
Under the best-case scenario, the policy should include everything that occurs following the approval
of a credit limit and terms such as the hows and whens of invoicing, follow-up calls, pre-due date
However, the company needs to be prepared for possible worst-case scenarios. If a customer does
not pay the invoice in a timely manner, the company should have a past due process. Things to
Enforcing the credit policy: Ensure everyone within the company, including sales and account
management, understands the circumstances in which the credit policy will be implemented and
Communication internally and with the customer: When an invoice is past due, who will
contact the customer? Will it be a member of the sales team, the account management team or
Expediting Payment: When collecting the past due payment, will new terms be made available
Collections Agencies: will the collection effort be outsourced (or insourced) to a third-party
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per year, per quarter, etc. In addition, its important to agree on the terms used for the formula. For
example, will your company use receivables, sales or revenue when calculating DSO?
For our purposes, we will use term sales for calculating average annual DSO. For that, the formula
is as follows:
Approx. 45.6 Days Sales Outstanding (indicates and average of 45.6 days to pay invoice). At Net 30
terms, avg. payment is 15.6 days late.
12. Conclusion
Creating, deploying and enforcing an effective credit policy may appear to be a mammoth task for
many organizations, however, in the long run, it positively impacts a companys bottom line. A large
number of companies, especially small businesses ignore this aspect and it reflects in their poor
growth. Companies devise new ideas and create new and innovative products (or services) to open
new revenue streams, but they often overlook having these in-house policies, which can improve the
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