Keys to a robust credit policy

 A credit policy refers to the processes of granting credit to your customers, setting payment terms and conditions to enable them to pay their bills on time, and recovering payments. It is like a playbook: it clarifies the plan of action in each type of trade credit situation, enabling all employees to know what they need to do and when.

This living document evolves as the company’s size and objectives grow.

Drafting your credit policy: 

As a business grows and becomes more complex, there comes a point when the unwritten rules are no longer efficient. Before this happens, this is very important to design and implement a credit policy that clarifies the order-to-cash journey. 

This document needs to reflect the company’s risk appetite and take into consideration margins as well as the product/geography mix, cash flow, and financing specificities.

Your credit policy should clearly address the following topics:

1. Credit department structure:

Your document should include an authority matrix identifying the role and responsibility of any employee involved in credit management. It should answer questions including:

• Who approves credit limits for each threshold?
• Who approves special terms and payment plans in case of overdue?
• What is the role of the sales team?

2. Know Your Customer procedure:

KYC is about identifying and verifying your customer’s identity when opening an account. In your credit policy, the KYC section should include the template of a comprehensive credit application form. It should outline required legal documents, verification processes, ownership structure, contact details, bank references, trade references, and details of any connected legal entities.

3. Credit risk assessment of new customers:

Collecting financial information is important but it is even more important to understand how the company works, its position on the market and external risks like political risk for international clients. 

You will need to define how to assess their reliability and what may constitute a red flag. A best practice is to apply a risk category for every customer in your portfolio by channel and from low to high-risk profile.

4. Terms and conditions:

The longer the payment terms, the higher the impact on your cash cycle and on your potential risk. In addition to the expected payment timeline, this section should include accepted means of payment.

You should also outline on which basis a customer may be converted from having to provide up-front payment to being granted credit and for which amount.

Your credit limit for each type of client should factor in the forecasted payment terms and volumes, but also the customer’s purchasing capacity based on the credit assessment.

5. Monitoring and managing risks

• How often do you re-assess customers and credit limits for each risk category?
• How do you monitor your concentration risk and top customers’ risk exposure?
• How do you handle red flags regarding your customers?
• How do you manage overdue or new orders from customers with an outstanding balance?

You can incorporate a compliance report procedure to track quarterly outcomes of any exceptions approved by management that are not in line with your credit policy.

6. Collecting procedures

Managing credit risk also means having clear procedures enabling you to act fast when things go wrong. Employees need to know which approach to use in communicating with their customers, as well as how to manage escalations and payment plan negotiation processes.

Is it clear at which point they should send the account to a collection agency or enter into a legal process?