A credit policy is the document that unites the internal/external departments of a company by setting standards of the credit practice that would be implicit throughout the organization.
- As Credit Managers we should know what we are empowered to undertake and achieve although the reasons for the empowerment is not always clear to the people outside the credit department.
- Most of the people regard the credit department as perhaps at best a necessary evil, but at worst an unnecessary overhead.
- This particular scenario is largely due to lack of education in matters related to credit and if allowed to continue, can soon undermine the hard working credit mangers, who find that nothing they do is regarded by other people as helpful in the running of the company.
- A number of times you will get comments regarding an overdue debt from people outside the credit department as under: –
- Why are you chasing client ABC?
- You know you upset client ABC
- You know client ABC will pay in time without being chased?
- Do not chase client ABC, as he is my friend.
If only these people making the above comments were aware of the companies’ credit policy they would have a different altitude and would support their fellow credit managers and equally the organization. If everybody in the company acted positively taking control of their altitude to collect money, it would improve results and cash flow in the company.
The negative altitude depends on how people perceive different departments and how they fit into the complete structure of an organization. It is by means of communication that much of this information is available.
Most of the credit problems are related to internal communications in the organizations. Lack of dialogue within some organizations is a disgrace and most of the companies who do nothing to correct these kinds of problems continue to trade when some of the departments are only out to make names for themselves and hence pulling into different directions.
A point important to note is that there is nothing that will pull a company down faster than departments going into different directions.
Communications is vital in building a structure where departments work together with each other and the issuing of a credit policy is one important step in the communication chain to the education of the internal customers of the credit department.
A credit policy will give the information necessary to indicate the importance of credit to a company and in order that some directions are instilled into a credit policy, there must be a purpose for its existence.
Two questions should now be answered at this point.
- Why should a credit policy be there?
- What does the credit policy do?
TYPES OF A CREDIT POLICY
Applicable in a monopolistic business environment
Applicable in a competitive business environment
FACTORS FAVOURING A CONSERVATIVE CREDIT POLICY
- Where demand exceeds supply
- Cash-flow is weak and tight collection policy is essential.
- Profit margins are very low and under threat from bad debts.
- The product is tailor-made for specific customers with little serious competition.
- Interest rates are very high and extended credit cannot be affordable.
FACTORS FAVOURING A LIBERAL CREDIT POLICY
- Stocks are high and product life or market is limited
- The product is, or is becoming obsolete
- A new product is being launched or a new market attacked
- Profit margins are very high and therefore more risk can be taken
- Market position is under threat from competition
Benefits of a Credit Policy
- Set out the company’s procedures of granting credit.
- Recognition of the credit department in the company.
- Removes any doubt or uncertainties over authority for payment terms, credit limits and acceptance of orders.
- Provide an operating guide for credit staff.
KEY FEATURES OF A CREDIT POLICY
- Standard terms of payments.
- Which personnel have authority to vary standard terms and under what conditions.
- Which personnel have authority to approve or reject prospective customers?
- Which personnel have authority to set or amend credit limits and risk categories?
- Which personnel have authority to refuse orders, suspend deliveries or take legal actions?
CONTENTS OF A CREDIT POLICY
- The companies business and aims
- Types of customers and business sectors
- Conditions of sale , as issued to the customers
- Payment terms
- Cash discounts
- Special arrangements, extensions, installments etc
- Interest charges
- retention of titles
- Bad debts
- D.S.O objective
- Systems of vetting customers
- Collection methods
- Staff responsible for implementing the policy
- Responsibilities of other departments to help achieve the company credit objectives
PURPOSE OF A CREDIT POLICY
The purpose of any credit policy is to define the credit function and to specify the objectives of credit and the responsibilities related to this function in order that the aims of the functions are understood and accepted by all internal customers in the organization and in particular the credit department.
Points to Note
- The credit policy will give a clear-cut direction on how credit business should be handled.
- It will avoid misunderstandings between the different departments.
- It will instill discipline to all stakeholders in the organization.
- It will guide the clients as to how they are supposed to go about the credit extended.
- It regulates the clients in the organization e.g.
- Guidance as to who should continue on credit or not.
- Who we should adjust the credit and how much.
FUNCTION OF A CREDIT POLICY
The main function of a credit policy is
– to protect the investment in the debtors of the company
– Maintaining the lowest level of receivables.
OBJECTIVES OF A CREDIT POLICY
To ensure that:
- Those sales on credit terms are made to maximize sales with the minimum risk.
- High risk or marginal accounts and especially those likely to get into financial difficulties are identified and to take whatever action is necessary to safeguard sales to those customers.
- An accurate and responsible data base of customers is operated and maintained.
- All amounts due are collected according to the agreed payment terms.
- Monthly cash collection targets are achieved.
- A high quality of accounts receivable is maintained.
The position of credit within the company should be fully defined so that there is no question as to who reports to whom or where the responsibility lies for reviewing new credit procedures and when.
The responsibilities of the credit department are as follows:
- The Credit department is part of the customer financial services and functions within the responsibility of the Managing Director.
- Credit department is responsible for all recommendations, decisions, and amendments made in accordance with the credit procedures of the company.
- The Managing Director must endorse any action beyond the recommendations of the credit department.
- All matters laid out in the operating principals are the responsibilities of the credit department.
- The Credit Manager is responsible for all actions carried out within the department.
A listing of the operating principals should be explained leaving no doubt as to whom is responsible for carrying out the requirements of the company and in what area. Explanation of the operating principals should be available in the credit control department and the Credit Manager should ensure that all staff has access to it and should also be a training aid for the new staff.
FORMULATION AND IMPLEMENTATION OF A CREDIT POLICY
Areas to cover
- Operating principles
- Credit application form
- Credit approval
- Credit control procedures
- Terms and conditions of sale
- Expectations from the customer
- Use of simple understandable language
- Consequences on non payment
- Clear conditions of trade
- Approval of orders
- Process of approval
- Chain of authority
- Who takes responsibility of what
- The sales ledger
- Documents involved
- Delivery of documents
- Customer house keeping
- Collection procedures
- Management support
- Demand letters
- Meetings on outstanding
- Staff matters
- Knowledge in credit management
- Who works where
- Awards & Bonuses
- Commercial conclusion of debts
- Legal procedures
- Write offs