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Sunday, August 28, 2011

Sample Of Credit Policy,How To Create And Maintain Credit Policy

Today we talk about sample credit policy and how to maintain it,
One of the chief causes of confusion not only within the credit
department but also between the credit and sales departments
is the lack of consistency in dealing with customer credit issues.
This includes who is responsible for credit tasks, what logical
structure is used to evaluate and assign credit, what terms of sale
are used, and what milestones are established for the collection process.
Without consistent application of these items, customers never
know what credit levels they are likely to be assigned, collection
activities tend to jolt from one step to the next in no predetermined
order, and no one knows who is responsible for what activities.

Establishment of a reasonably detailed credit policy goes a
long way toward resolving these issues. The policy should
clearly state the mission and goals of the credit department,
exactly which positions are responsible for the most critical
credit and collection tasks, what formula shall be used for
assigning credit levels, and what steps shall be followed
in the collection process. Further comments are as follows:

Mission. The mission statement should outline the general
concept of how the credit department does business: Does it
provide a loose credit policy to maximize sales, or work toward
high-quality receivables (implying reduced sales), or manage
credit at some point in between? A loose credit policy might
result in this mission: ‘‘The credit department shall offer credit to
all customers except those where the risk of loss is probable.’’

 Goals. This can be quite specific, describing the exact performance
measurements against which the credit staff will be judged.
For example, ‘‘The department goals are to operate with no
more than one collections person per 1,000 customers, while
attaining a bad debt percentage no higher than 2 percent of
sales, and annual days sales outstanding of no higher than 42 days.’’

 Responsibilities. This is perhaps the most critical part of the policy,
based on the number of quarrels it can avert. It should firmly state
who has final authority over the granting of credit and the assignment
of credit hold status. This is normally the credit manager, but the policy
can also state the order volume level at which someone else, such as
the CFO or treasurer, can be called upon to render final judgment.

 Credit level assignment. This section may be of extreme interest to
the sales staff, the size of whose sales (and commissions) is based on it.
The policy should at least state the sources of information to be used
in the calculation of a credit limit, such as credit reports or financial
statements, and can also include the minimum credit level automatically
extended to all customers, as well as the criteria used to grant larger limits.

 Collections methodology. The policy can itemize what collection steps shall be
followed, such as initial calls, customer visits, e-mails, notification of the sales
staff, credit holds, and forwarding to a collections agency. This section can be
written in too much detail, itemizing exactly what steps are to be taken after a
certain number of days. This can constrain an active collections staff from
taking unique steps to achieve a collection, so a certain degree of
vagueness is acceptable here.

 Terms of sale. If there are few product lines in a single industry, it is useful to
clearly state a standard payment term, such as a 1 percent discount if paid in
10 days; otherwise full payment is expected in 30 days. An override policy can
be included, noting a sign-off by the controller or CFO. By doing so, the
sales staff will be less inclined to attempt to gain better terms on behalf
of customers. However, where there are multiple industries served with
different customary credit terms, it may be too complicated to include this
verbiage in the credit policy.

Company management can experience significant losses if it loosens the
credit policy without a good knowledge of the margins it earns on its products.
For example, if it earns only a 10 percent profit on a product that sells for $10
and extends credit for one unit on that product to a customer who defaults,
it has just incurred a loss of $9 that will require the sale of nine more units
to offset the loss. On the other hand, if the same product had a profit of
50 percent, it would require the sale of only one more unit to offset the loss
on a bad debt. Thus, loosening or tightening the credit policy can have a
dramatic impact on profits when product margins are low. Consequently,
always review product margins before altering the credit policy.

When economic conditions within an industry worsen, a company whose
credit policy has not changed from a more expansive period will likely
find itself granting more credit than it should, resulting in more bad
debts. Similarly, a restrictive credit policy during a boom period will result
in lost sales that go to competitors. This latter approach is particularly
galling over the long term, since customers may permanently convert to
a competitor and not come back, resulting in lost market share. To
prevent these problems, schedule a periodic review of the credit policy
to see when it should be changed to match economic conditions. A
scheduled quarterly review is generally sufficient for this purpose.
To prepare for the meeting, assemble a list of leading indicators for
the industry, tracked on a trend line, that show where the business
cycle is most likely to be heading. This information is most relevant
for the company’s industry, rather than the economy as a whole,
since the conditions within some industries can vary substantially from
the general economy. If a company has international operations, then
the credit policy can be tailored to suit the business cycles of specific

If a company’s products are subject to rapid obsolescence, a tight
credit policy can result in limited product sales that leave excess
quantities on hand that will be scrapped. In such cases, loosen the
credit policy on those inventory items most likely to become obsolete
in the near term. The logic is that, even if inventory is sold to
customers with a questionable ability to pay for the goods, this at
least presents higher odds of obtaining payment than if the
company throws away the goods. To implement this approach,
keep the credit department informed of the obsolescence status of
inventory items, usually by having the sales, marketing, and logistics
staffs flag potentially obsolete items in the inventory database
and giving the credit department online access to this information.
When customers send in orders, the credit staff
accesses this information, verifies the obsolescence status
of the items ordered, and modifies the credit policy as needed.

Tags: sample credit policy

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