Developing the right credit policy for your business

Many SMEs will often extend credit in their business in order to try and grow their customer base as quickly as possible. By extending credit, you can attract new customers, improve your profit, as well as increase your overall sales and market share.

However, it's important to remember the risk that can be associated with credit. Therefore you should always ask yourself the question 'who is a good credit risk and who is a bad credit risk'.

A good credit policy will help you determine the customers capable of paying on time and those who don't. The policy will become your guideline to help you identify who you will provide credit to, how much credit you will provide and how you will monitor that credit once it has been provided.

The challenge will be identifying how much credit you extend and how many customers you extend credit to. A credit policy that has strict guidelines is fine but it can limit the number of new customers you will attract and ultimately affect how much your business can grow.

When deciding on a credit policy you should first determine how extending credit will impact your business variables and consider the processes necessary to deal with any subsequent changes.

Some important questions to consider when deciding on a credit policy are:

  • Do you have the required cash flow?
  • Do you have a system in place for receivables?
  • How will you assess a customer's ability to pay?
  • How will you collect accounts if they become overdue?
  • Is your product priced accurately to reflect the cost of granting credit (i.e. protecting your income)?

But how do you decide on a policy? Some key considerations to keep in mind when developing your policy are:

  • Total amount of credit you can afford to extend
  • The maximum credit you will extend per customer
  • A timeframe you will allow for payment
  • The possibility of offering discounts or penalties for early and late payments
  • Information you will include on your credit application form
  • Who will be your credit contact and who will be your customer's credit contact?

By following the above considerations and questions you should be able to create a policy that will clearly set out how you extend credit inside your business. You willthen be able to define the type of customers or prospects you provide credit to and what terms you provide the credit on.

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