The credit policy is an essential document for any company, but especially in the construction sector, which is heavily credit oriented. Your company must clearly define its philosophy regarding the extension of conditions to customers and the collection of overdue accounts. If there is no plan, there is no hope of survival.
What is a credit policy?
Simply put, a credit policy is a set of guidelines that :
- Are used to determine which customers are extended credit and charged.
- Define the terms of payment for the parties to whom the credit is extended.
- Define the limits to be set for outstanding credit accounts.
- Describe the steps or procedures used to process overdue accounts.
- When broken down into its constituent parts, a credit policy seems to summarize how a risk-averse company faces credit extensions and other monetary policies related to accounts receivable.
Many businesses, usually retail establishments selling goods or services to individuals, rarely extend credit and require payment upon purchase. For this type of business, a credit policy is not a priority, and that makes sense.
For most other activities, including those in the construction sector, a sound credit policy should be an integral part of the company’s business plan, monetary policy and overall risk management strategy.
Credit policies define credit terms, credit limits, the type of customer to whom credit will be granted (information required before extending credit to a new customer, i.e. a credit report? Number of years in business? etc.), and policies for dealing with late payments and delinquent accounts.
How to define an effective credit policy?
Once you have decided to formalise your credit policy, whether you are creating it from scratch or reconstructing it from elements that your company already has in place, the question that arises is: how can I add value to my credit policy?
The ultimate objective of all credit policies is to maximize the company’s income and activity while minimizing the risks generated by the granting of credit. Credit policies are generally not ready-to-use or take-away products. The means to achieve this may vary depending on many factors, such as the size of the company, the specific cash flow of the company, the industry in which the company operates and the general economic climate. Let’s take a look at the 6 steps to defining an effective credit policy below.
The 6 steps to defining an effective credit policy
- Analyze the initial situation. The prerequisite for improvement is to know where your organisation is at the moment.
- Set a target figure. Ask yourself what exactly are you aiming for with your credit policy?
- Build a team you can trust. Teamwork is important, because each department must take its role seriously. The marketing department must initiate activities that generate a return on investment or the customer service department must react to customer complaints.
- Define the credit procedure. The credit procedure could vary according to each type of customer. Safe customers could have more opportunities, while risky customers would be more monitored.
- Set up a credit and collection system. Now that your objective and the procedure have been established, there is one more important step to take. Redefine your existing computer systems in order to introduce your new system.
- Continuously improve. A few months later, you will be able to evaluate future improvements.