The Ultimate Guide to Creating a Robust Credit Policy

07/11/2024
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A credit policy is a documented set of guidelines that establish the method, terms and repayment of customer credit. How strong is your credit policy?

If you offer credit to your customers, having a clear credit policy is a must. It protects your business and your team from the risks of late payments and bad debt. Without it, you’re leaving yourself open to serious cash flow problems.

Your credit policy should be easy to understand and shared with all your staff. Make sure they’re trained on it too. If they don’t understand your policy, they might end up dealing with unreliable customers who pay late or not at all. By ensuring everyone knows and follows the credit policy, you’re setting your business up for smoother, more reliable operations.

Analyze customer risk against your credit policy

Chapter 1

Creating a robust credit policy 

Risk level

Here’s why a good credit policy matters:

1. Outlines risk criteria and credit rules: A solid credit policy sets clear parameters for what your company will accept in terms of risk and put the protections in place to avoid getting stuck with late-paying and unreliable customers.    

2. Helps your team do their job better: When your team knows your business credit policy, they can be more productive and effective in their roles. Plus, they can make better credit decisions that help the business grow long-term.

3. Generates more revenue for the business: In our recent study ‘The Sales vs Credit Control Battle’ we found almost half (47%) of surveyed professionals confirmed they have up to 10 sales deals rejected each month by the finance team. Another 13% reported between 11 and 15 sales deals being rejected monthly, and 56% admit their deals are often or sometimes rejected. These rejections highlight a significant disconnect between sales and finance teams.

4. Implementing a clear, easy-to-understand credit policy can bridge this gap. When both teams are on the same page, confusion and mistakes are minimized, leading to more new customers being approved. This improved alignment helps close more sales deals, ultimately generating more revenue for the business.

5. Protects your business from risks. With everyone following the same rules, you can count on more consistent and dependable business practices.

To make this work, your credit policy should be straightforward and clearly communicated to all teams, especially those who are involved with identifying prospective customers and approving sales deals (i.e. sales and finance/credit control teams). Train your employees on it thoroughly. This way, they’ll know how to spot red flags and handle credit wisely. When everyone understands and sticks to the credit policy, you can focus on growing your business without worrying about unexpected financial setbacks.

Do you know which customers pose a risk to your business?

Chapter 1

How to create an effective credit policy

There are several factors you should consider to create an effective credit policy. 

Credit processes

Determine your risk level

How many customers can you put on credit?

Not every customer needs credit terms. Decide how much revenue you can have outstanding at any time and offer credit to your most reliable customers first. You’ll need to reassess this regularly as circumstances can change within your business. 

How much credit are you comfortable extending to customers?

Know your limits. Set clear limits on how much credit you’re willing to extend overall every month. This varies but is typically 10-20% of your monthly revenue.

How effective is your team with collecting debt? 

In our recent study ‘Perils of Rising Debt & DSO’ we found that only 14% of businesses reported that most (76-100%) of their invoices are paid on time. Late payments are a common challenge, with 39% of businesses experiencing customers paying 1-30 days past payment terms in the last 12 months. Additionally, 46% reported payments 31-60 days late, and 15% experienced payments 61-90 days past due.

Understanding how long it takes each customer to pay is crucial. Some customers may consistently pay a few days late, while others might have shifted from on-time payments to being 30-45 days late over the last six months. Assessing your team's effectiveness in collecting debt and your comfort level with handling collections is essential as you build your policy.

Identify your ideal credit applicant

Who are your current best customers?

Identify and segment customers based on risk, focusing on those with a strong track record of paying invoices on time or only a few days late for 12+ months. Additionally, review their business credit reports to assess their financial health and payment behavior with their own suppliers. This approach ensures you prioritize customers who align with your financial risk tolerance.

Who are the best credit customers of others in your industry?

Use third-party data and credit references to create an ideal credit customer profile. Base this profile on information from their business credit report and external financial data such as sales and revenue. Compare their Days Beyond Terms (DBT) to the industry average to evaluate how customers perform relative to others in the industry. Continuously update this profile as you gather more information. 

Set your ideal payment timeline

What is standard in your industry?

Use third-party data to determine industry-standard terms. Know what your competitors offer before setting your terms.

How quickly do you need to see repayment?

While industry standards are important, tailor your terms to your company's risk tolerance. Decide how long you can wait for repayment. Base your repayment terms on information from business credit reports. Assess if more than 50% of their payments have been past due in the last 12 months, if the number of late payments has increased significantly over time, if their revenue has declined, and if their business credit score and credit limit have changed significantly recently. Use this information to set the most appropriate payment terms, such as Net 30, Net 60, or Net 90, tailored to your company's risk tolerance.

How long can your cash flow withstand not being paid?

Plan for delays. Ensure you have enough time for collections built into your credit policy to avoid jeopardizing your business. Conduct financial analysis based on previous years, including cash flow forecasting, budgeting, and planning for operating expenses. Review customer payment behaviors over the last 12-24 months (about 2 years) to identify trends and risks. This comprehensive analysis will help determine how long your cash flow can withstand delayed payments, ensuring you build sufficient time for collections into your credit policy to avoid jeopardizing your business.

Define your collections strategy

What is your tolerance and timeframe for collections? 

Collecting payments from customers is critical for growing your business. Your revenue isn’t growing, you won’t be able to pay for the company’s operating expenses. And you won’t be able to keep up with and beat the competition. That is why you need to set boundaries for how long you’re willing to wait to receive payment from your customers. And set clear processes for what you’ll do if customers exceed that timeframe. Decide upfront how you'll handle this. You might grant more time, send formal letters, write off certain amounts, etc.

Are collections managed in-house or outsourced?

Decide if collections will be handled internally or outsourced. If outsourcing, collaborate with an agency or law firm to craft this part of your policy.

What are the legal considerations for your state, country, or industry?

Consult a lawyer versed in credit laws to ensure compliance with all applicable guidelines.

Payment terms

Create internal processes

Documentation:

Document everything included in your credit policy. Provide key terminology and definitions that your employees might not know. Explain each element clearly, using examples where possible.

Key Terminology: 

Credit Score: A numerical representation of a person's or business's creditworthiness, based on their credit history.

Credit Limit: The maximum amount of credit that a lender is willing to extend to a borrower.

Days Beyond Terms (DBT): A company’s DBT refers to the number of days it typically takes to pay invoices beyond payment terms. For example, if a company has a DBT of 15, then it pays its invoices 15 days past payment terms. This data is collected from the Creditsafe platform. 

DBT over the last few months: The average number of days beyond the agreed payment terms that invoices remain unpaid over the past year.

Industry average DBT: The average number of days beyond payment terms that invoices remain unpaid within a specific industry.

Percentage of late payments over the last 12 months: The proportion of total payments that were made past the due date over the past year, expressed as a percentage.

Create guidelines

Guidelines help your team adhere to your business credit policy. Include the following:

  • Credit application format

  • Required documents

  • Criteria and timeline for approval 

  • Credit limits and terms

  • Early repayment discounts

  • Consequences for non-repayment

  • Collections process 

  • A workflow assigning responsibility

Communicate your policy clearly

Simply creating a credit policy isn't enough. Communicate it clearly and transparently. Create a communication matrix to specify who will communicate the policy and how. Encourage a two-way dialogue for feedback from employees and customers.

Chapter 1

Tap into the power of integrations and data to create a robust credit policy

Third-party data

A comprehensive credit policy should outline how to use third-party credit data. Specify how it will be analyzed, key indicators, frequency of reference and data sources.

CRM integration

Integrate credit data into your CRM platform to gain a clear picture of every prospect and customer at the start of the selling journey. This allows you to identify risks upfront, avoid last-minute deal rejections by the finance team, and generate more long-term revenue. Efficient updates and robust decision-making reduce clerical errors and enhance accuracy. 

Automated decision-making

Implement automation for straightforward credit decisions, such as likely approvals or rejections, to save time and ensure accuracy. By incorporating automation into your credit policy, the finance team can focus on analyzing more complex deals, saving significant time and money while reducing the likelihood of rejected deals.

Changes and alerts

Establish how to monitor existing customers for credit risk changes. Set up alerts for significant changes and assign responsibility for responses. Get these alerts in real time across various platforms, for example ERP, CRM, or the Salesforce app.  

Creating a robust credit policy is key to protecting your business from late payments and bad debt. A clear policy sets risk criteria and credit rules, helping your team make smart credit decisions. By using third-party data, setting payment terms that fit your risk tolerance, and having clear internal processes, your business can run smoothly. CRM integration and automated decision-making further streamline operations and reduce errors. When everyone understands and follows the credit policy, you can confidently grow your business.

Analyze customer risk against your credit policy

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