Creating an Effective Credit Policy for Your Business
Extending credit to your customers can increase sales, profits and loyalty. First, put together a policy that protects your business.
Growing businesses sometimes make a crucial mistake when they extend credit to their customers. Rather than establishing a clear, consistent policy, they may do it haphazardly, with different terms for different clients. The result is a confusing maze of promises and inconsistencies that can confuse staff and frustrate customers.
The better route is to set a credit policy that works across your customer base, taking into account both terms and conditions, penalties for late payments and potential paths for resolution. By putting a policy in place and ensuring that your customers receive it at the time of the initial sale or before, you can better manage expectations and minimize problems that could jeopardize the relationship later. Here are the basic steps involved.
1. Know your own terms
The terms you give your customers should be the same as, or less than, what your suppliers give you. Otherwise, the difference comes out of your pocket. "If you're getting 45-day terms from your suppliers, you can't give your customers 60-day terms," explains Patrick Ross, a partner at Haskell & White, a CPA and business advisory firm in Irvine, CA.
2. Set expectations
Your credit policy should be a simple document that's easily understood by your customers – and your own staff. Its terms will help allow you to collect interest on past due payments without dispute, for example, or receive binding guarantees from owners of LLCs and LLPs.
You should have an attorney or financial advisor draw up the document so it has no ambiguity. It should include:
- When payment is expected
- What percentage of the total amount due is expected
- What constitutes an overdue account
- What penalties accrue
- What interest rates are added to overdue accounts
- How returns and shipping charges are handled
Have customers sign the policy and keep a signed a copy for your records, so no one can claim ignorance if your original contact leaves the company.
3. Segment your customer base
Ross recommends segmenting your customer base, using criteria such as size, length of the relationship and sophistication. For instance, you may want to be more flexible in accommodating your biggest customers or those whom you know well. Sophistication relates to how quickly and reliably they pay. "If someone can wire you money or submit ACH payments, you don't have to deal with the uncertainty of hearing that the check is in the mail," Ross says. "You may want to give those customers better terms." Or, you may decide to offer a good customer the option of an installment plan for making payments, though Ross recommends this be used in limited situations.
4. Run credit reports regularly
A common mistake, Ross laments, is that businesses will receive a credit report or reference check at the time that the relationship is established and then stick it in a folder never to be seen again. An easy way to keep credit issues from becoming bigger problems is to periodically ask for updated reports, especially in times of economic volatility. Confirm the information submitted and payment status of the account before extending credit.
5. Learn from adversity
If you frequently have problems with your credit collections, Ross recommends stepping back and analyzing what went wrong. "Think about your worst collection problems and document the circumstances," he says. "Identify trends and then learn from your mistakes. Devise a solution and implement it in an updated policy."
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