5 Steps to Create a Robust Credit Policy

What is a Credit Policy?

A documented set of guidelines that establish the method, terms, and repayment of customer credit and include provisions for collections if the debt is unpaid.

5 Steps of Creating a Credit Policy

There are several factors and information that need to be discussed when creating a credit policy. 

  1. Determine Your Risk Tolerance 
  2. Determine Your Ideal Credit Applicant 
  3. Determine Your Timeline 
  4. Determine Your View of Collections 
  5. Determine Your Process 

1. Determine Your Risk Tolerance 

  • How many customers can you put on credit?  
    • When you are creating a credit policy, not every customer needs to be offered credit terms. Determine amount of revenue you are able to have outstanding at any one time and then offer portions of this to some of your best and most reliable customers. Start with a select group and then grow the option to include more as you are comfortable.  
  • What is your financial availability for extending credit? 
    • You need to know how much total revenue you are comfortable extending via credit at any one time. This is different for every business and industry but is generally somewhere between 10-20% of monthly revenue. 
  • How comfortable are you with collections?
    • Unfortunately, there will always be customers who do not or are unable to pay what they owe. This inevitability means that you must understand how comfortable you are with and how you will handle collections as you begin crafting your credit policy. 

2. Determine Your Ideal Credit Applicant

  • Who are your current best customers? 
    • Look at your loyal customers, especially those who have a strong tie to your business, rely on your product or service, have a reputable history, and who’s ordering history fits within your financial risk tolerance.  
  • Who are the best credit customers of others in your industry? 
    • Using third party data and credit references can help you create an ideal credit customer profile that can be measured against your current customers when deciding which businesses should receive credit offers at first. This should be constantly updated as you learn more

3. Determine Your Timeline 

  • What is standard in your industry?
    • Use third party data to determine the terms that are standard in your industry. See what your competitors and partners are offering before unilaterally deciding on terms.  
  • How quickly do you need to see repayment? 
    • While understanding industry standards is important, in the end it is all about your company’s risk tolerance. How long are you able wait for repayment? This has to be factored in to the overall terms that you are willing to offer.  
  • How long can you actually last without getting paid? 
    • Repayment may not happen on time or at all. What percentage of the credit offered are you able to handle not receiving in a timely manner? Make sure that you have adequate time for collection built into your credit policy before you endanger the functionality of your business due to credit that was extended.  

4. Determine Your View of Collections 

  • What is your tolerance and time-frame for collections?
    • Collections is inevitable when you are offering credit. Determine in the beginning how you will handle this. You may choose to grant more time, to have formal letters sent, to write off certain amounts, or a variety of other things. Figuring this out up front will make sure you are setting proper guidelines and can communicate them up front to all parties involved.  
  • Will this be done in house or will you outsource it? 
    • Collections doesn’t have to be done by your company. Determine now what your preference is and how you will handle this issue so that if you are going to outsource, that agency or law firm can help you craft the collections portion of your credit policy. (CCA of A Link) 
  • What are the legal considerations for your state, country, or industry? 
    • Make sure to speak to a lawyer that is versed in credit to make sure that you are following all applicable local, state, and federal guidelines as it pertains to your specific business.  

5. Determine Your Process

  • What is standard in your industry 
    • Use third party data to determine the terms that are standard in your industry. See what your competitors and partners are offering before unilaterally deciding on terms.  
  • How quickly do you need to see repayment? 
    • While understanding industry standards is important, in the end it is all about your company’s risk tolerance. How long are you able wait for repayment? This has to be factored in to the overall terms that you are willing to offer.  
  • How long can you actually last without getting paid? 
    • Repayment may not happen on time or at all. What percentage of the credit offered are you able to handle not receiving in a timely manner? Make sure that you have adequate time for collection built into your credit policy before you endanger the functionality of your business due to credit that was extended.  

Getting Started

When it comes to creating a credit policy, there are a few basic actions and steps you should be taking. 

  1. Documentation
  2. Guidelines
  3. Communication

Documentation 

Document everything you are doing in the credit process. Provide a brief overview of what is happening as well as the rationale for why it is done. This will help to inform those within your company, your customers, and help to guard you from potential legal issues.  

Guidelines 

Every Credit Policy needs to contain the guidelines for: 
  • What the credit application looks like 
  • The necessary documents for the credit application 
  • The timeline for approval of credit 
  • Who qualifies for credit  
  • How much credit they qualify for 
  • What terms can be offered 
  • What credit limit can be offered  
  • How terms and limits can be changed 
  • Discounts for early or quick repayment 
  • The ramifications for non-repayment
  • How the collections process will happen
  • A workflow that establishes responsibility for each part of the process to a particular position, not a particular person 
  • Other items may also be included, but at a minimum the above items should be included.  

Communication 

  • Make sure that all parts of the credit policy are documented and kept in a master file to be referenced often. 
  • Create a communication matrix that states which position will initiate the conversation and when they will do so.
  • Make sure that the communication is a two way street. Establish a process for receiving feedback and other information from customers. 
  • When in doubt, communicate your thoughts and process, while documenting everything that is shared. 

Getting Sophisticated

Automation & Integration

Third Party Data

A comprehensive credit policy should include the guidelines for using third party credit data. How this data will be analyzed, what key indicators will be used, how often this will be referenced, and who the data comes from should all be outlined within the policy. 

CRM Integration

Often the easiest and most efficient way to handle credit data is to integrate it directly into your existing CRM. This allows for customer information to be updated automatically and provides for a more robust decision making process. This also helps to prevent costly clerical or administrative errors. 

Automated Decision Making

Much of the credit process and many of the credit decisions that need to be made are common to particular businesses. If these decisions can be defined, then they can be automated. Automation allows for quicker and more accurate decisions and leaves more time to consider the harder or more complex applications. A strong credit policy should have provisions on how and when this is done as well as what type of system or software will be used to automate these processes. 

Changes and Alerts

Changes happen in a blink of an eye. A complete credit policy should outline how existing customers will be monitored for changes to their credit risk profile. It should also establish when and for what changes alerts, such as automatic emails, should happen. Additionally, the policy should explain whose responsibility it is to respond to changes or alerts. 

Monitoring & Updating

Manual Monitoring

Manual monitoring is the process by which a credit or finance department uses its human resources to update the credit risk profiles of its customers. This process is often done annually and can be time consuming and ineffectual, but has been done for many years in companies all over the globe. 

Automated Monitoring

Automated monitoring is the preferred method for the credit industry. This allows for real time, automated updates of all the credit risk profiles within your portfolio. When integrated into your CRM and used in conjunction with automated alerts, automated monitoring becomes a powerful tool in your credit management toolbox. 

Updating Credit Risk Profiles

When customers are consistently monitored, it is imperative that their credit risk profile be updated to reflect any changes. This can be done manually, but it is preferable to do this through an automated process. A strong credit policy will have the guidelines and timetables around how these updates are accomplished along with whose responsibility it is to ensure the updates happen. 

Other Considerations (Coming Soon)

  • International Considerations
  • Industry Niche Considerations 
  • Credit Policy and Sales 
  • Credit Policy and Marketing

Credit Policy FAQs

  • What is a credit policy?
  • Does my company need a credit policy? 
  • What tools are available to help me make credit decisions?  
  • How often should I update my credit policy?  
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