Credit policy - how to design and apply an effective credit policy in your business
Do you face challenges with bad payers from time to time? Do you find that your customers often pay late or don't pay at all?
Whether you experience bad debt or not, an effective credit policy is the key to safeguarding against bad debt, regardless of the size of your business. This ensures greater financial stability and minimizes financial losses.
By having all staff (e.g. in accounting, sales or customer service) working from a common and streamlined credit policy, you can minimize or even avoid losses on your customers.
Read also: Your credit policy should look different in 2023
What is a credit policy?
A credit policy is a policy that consists of a set of rules for your credit to your customers. In other words, who and how much our customers can buy from us on credit.
The scope of a credit policy depends, for example, on the size of the company, the number of customers and, not least, the size of orders. Some credit policies are very comprehensive and nuanced, while others are simple but often just as effective as the more comprehensive ones.
Why a credit policy?
Most people don't think about it, but when you let a customer leave your shop without paying for the goods and with an invoice in hand, you have given your customer credit. This is an inherent risk. A risk that the customer will not pay your invoice or may simply pay it late. What are the consequences for your business?
If your business, like many others, offers invoice payment, your company should have a strict credit policy in place to reduce the risk of losses and excessive outstanding balances.
Where do we start?
There are many places to start when implementing a credit policy. But we recommend that you start by looking at the credit limit and who you want to offer credit to.
Do all customers need credit? Does the customer have to be a customer for 1 or 2 years to get credit? If the amount exceeds a certain size, does it need to be approved by a finance manager? Are there specific business types and customers that should be offered a different credit limit? What is the maximum amount a customer can owe you before they can collect the next item and should this limit be the same for everyone - or perhaps higher for good customers?
Credit policies vary from company to company, but the above are good questions to ask yourself when designing your policy. A risk policy needs to be balanced against your company's risk appetite and the (perhaps) extra work involved in complying with the credit policy and framework. It is important that you identify your risk and that you are aware of the increased risk of having few customers with large amounts outstanding to you.
Many companies choose to set a low credit limit for new customers. A limit that continuously increases as the customer orders more products and pays on time. Conversely, the credit limit could be lowered if the customer consistently pays late. Some customers may no longer need to be offered credit at all if their payment history does not justify this offer.
You set the framework for your own risk policy.
No two industries are the same - keep this in mind when implementing your credit policy
Fortunately, no two businesses are the same - and neither are most industries.
Too often, we see that many people don't realize that some industries need more credit than others. You should therefore take this into account when drafting your credit policy.
While the self-employed hairdresser may not have a great need for credit, the craftsman with a large staff may need to regularly collect many and expensive products from your company, and thus a higher credit.
Other industries may have credit as a competitive parameter, such as with the craftsman, who can buy materials and may even have time to finish and invoice the job before these have to be paid.
Credit rating or not?
Should all companies be treated equally or should healthy companies have more advantages when it comes to credit?
Credit ratings are a valuable tool when you want to continuously analyze your customers' financial situation. At Collectia, we have developed our own credit platform, Qatchr, which can credit check Danish companies. With a credit check via Qatchr, we collect credit information that you can use in your own credit rating. But also free services like Proff.dk and CVR.dk can provide you with very useful information.
With a credit rating, you can determine the risk and risk profile your customer should have. Poor key figures may result in no credit or shorter credit terms.
The credit check can either be done on all customers or just the ones with the highest risk; based on industry or perhaps the total purchase from the customer.
How do we comply with the credit policy?
Of course, an effective credit policy is worth nothing if it is not respected. That is why it is important to establish a framework and procedures to ensure compliance with your credit policy.
It can be as simple as: what do we do with new customers? Does someone have to authorize credit for customers? And how do store staff deal with customers who have an outstanding balance with you?
Most accounting and ERP programs today allow you to set a credit limit on a customer, so make sure you make use of this feature. If your accounting program doesn't have this feature, sales and store staff will need to get an overview of the customer's outstanding balance before new items are sent out to the customer.
Want to know more?
Write to us using the form below. You are also welcome to call us on 77 30 14 80 or send an e-mail to salg@collectia.dk. We'll be in touch!
