A good credit policy structure is necessary for businesses that sell their products on credit terms. Failure to do so will make customers think the business owner is not serious and result in bad debts. This can close down a business if not tamed.
Credit policy means a policy on how and who to allow credit sales. Credit sales bring trade receivables (debtors) to a business. It has become normal behavior for debtors to avoid paying their debts unless the business owner requests it. So, the need to have a credit policy.
There are three types of credit policy via lenient, stringent, and flexible policies. Lenient type sells on credit to customers on very liberal terms. It may grant the customer credit for a long period and doesn’t bother about the creditworthiness of the client.
Stringent credit policy ensures that the business product is sold on credit only to financially reliable customers with a good credit score. While flexible policy sells to clients on credit based on management decisions. Flexibility means leniency will be applied to certain clients while others will be on a stringent basis.
What you should consider before setting a credit policy
The following factors must be considered by a small business owner before deciding what credit policy best suits his or her entity.
- Company’s bargaining power
- Customer’s requirements
- Status of the clients
- Relationship with clients
- Marketing tools
- Industry practice
- Transit delays
What makes up a good credit policy
The following factors are included in a credit policy
Credit standard. This is the criteria to decide the customers that deserve credit sales.
Credit terms. That’s the duration of the debt and the terms of payments by the customers
Collection effort. The activities the business will perform to ensure the collection of debt. This includes sending proforma invoices through emails, sending text messages, and making phone calls.
Importance of Credit Policy to Small Business
Business structure. It is important to put structure in place for your business. Lack of credit policy means lack of core structure. This structure helps you keep clients and employees in check. When customers are not complying with the policy efforts can be made to recover the debts.
Increase in sales. Selling on credit helps increase sales of goods, thereby improving the company’s value. If the entity decides not to sell on these terms it may lose sales, customers and inventory may expire in the warehouse or shelf.
Build customers/business relationships. Selling on credit terms builds good relationships with customers. Why? From time to time, emails, text messages, and telephone calls will be made to the customers to remind him or her of the debt. This makes the customer familiar with the entity and believes that they mean business.
It shows seriousness. If an entity strictly follows its credit policy, customers have no choice but to comply. It also makes them believe that the business is serious about what they do. Thereby, building trust and confidence.
Special discount. When clients can not meet credit terms, the business owner may give a special discount to encourage the clients to make payments.
Avoid loss of profit. A good policy helps reduce bad debt and impairment (provision for bad debts). The lower amount of impairment means more profit to the entity.
Credit policy is an important business structure. The entity has to decide how and who debts should be given to. And how to recover such debts. Failure to do so may result in huge amounts of bad debts and impairment which will erode the business profit.