Warren Buffet, one of the most successful investors in the world and currently the world’s third richest person, once said “Rule number 1: Never lose money. Rule number 2: Never forget rule number 1”. As a credit professional you understand that for your business to survive you need it to be profitable and for it be profitable you need to protect it from risk. However, if you do not have a well-constructed credit policy this becomes impossible.
A credit policy can be described as a blueprint for the granting and maintenance of credit. It should be seen as a comprehensive “how to guide” or “rules of engagement” that clearly describes the company’s strategic and operational requirements from credit sales. If however your credit policy is below par or lacking in certain areas it may be hampering your ability to make decisions that benefit your company and grow profits.
Read through the list below and make sure that you are not making any of these critical mistakes in your credit policy.
- You do not have a mission statementWithout a mission statement your credit team will not know their function. The mission statement needs to explain the overall purpose of the department as well as who you want to grant credit to. The purpose of the credit department will delineate the their function and goals so it is important to take the time to make sure this is correct. Remember that your mission statement should be kept brief – it is not there to discuss individual procedures but merely what you hope to achieve with them.
- There are no clearly defined levels of authorityIf you do not have clearly defined levels of authority the credit department does not know the direct route to take during the credit approval process. This may severely hamper the efficiency of the approval process resulting in it taking far longer than necessary. Always check that you do not have an overly cumbersome and over-engineered approval process.
- You do not detail the credit application process and necessary documentationIt is essential that your credit policy includes standard documentation such as loan application forms, credit checking forms, software and standard loan contracts. Details also need to be given as to how the application form should be filled out while a form or checklist can help assure that the customer was explained how to complete the application form according to the organisations policies and procedures.
- The credit evaluation process is not thoroughly explained or consistentIf the credit evaluation process is not clearly defined it can result in severe inconsistencies appearing in the approval process. Remember that there are a range of data sources that can be used to determine creditworthiness so it is essential you clearly explain which need to be used to evaluate a potential applicant. To guarantee consistency make sure you develop a credit evaluation scorecard so that all employees are following the same procedure.
- You do not have guidelines for setting credit limitsWhen setting your credit limits remember that your goal should be to provide freedom to low risk, prompt paying customers and more conservative limits for your slower paying customers. For this reason ensure that your limits have some flexibility and assign limits based on the customer ability to repay debt.
- Instructions for the disbursement process are not clearly outlinedIt is essential that within your credit procedures that you outline the details and specifics for disbursement. Details such as final agreed upon amount, delivery arrangements, payment terms and right to charge interest on late payments all need to be clearly outlined in your instructions.
- Defined plans are not in place for bad debt collectionIn order to quickly resolve instances of accounts in arrears and missed payments you need to ensure all your staff immediately know what to do so that no time is wasted. Comprehensive plans and procedures need to be in place for how to handle aged accounts including when to make collection calls, bad debt collection letter templates, when to place accounts with a collection agency and at what stage to pursue legal action.
- Your credit procedures do not include guidelines for portfolio planning and managementIf your credit procedures do not detail guidelines for portfolio management your company will not understand the status of its current customers nor have sufficient record keeping. Remember that you need to evaluate your customers on a regular basis and clear guidelines need to be in your policy on how to do this. This section of your credit policy should ultimately summarise the sources of information which are to be used for the re-evaluation process and which records should be kept in this regard.
- The credit policy is out-datedHaving a credit policy that has not been updated in years is as bad as not having one at all. Remember that this needs to be a “living document” that evolves as your company changes. Once a year review the entire policy and update any irrelevant information. Remember that changes both within your organisation and outside of it can determine that you revise your policy.
- You do not include all Terms and ConditionsThis section of the credit policy makes provision for the rules of the company regarding if and when credit will be granted as well as the conditions surrounding the granting of credit. In particular it should highlight the procedure when dealing with specific credit granting situations such as staff loans, credit to foreigners and rules regarding the handling of customers that fall behind on their payments. When writing a credit policy, always be clear about what you expect from the beginning regarding your terms and conditions and ensure that they are thorough. Also be sure to detail how the customer is to be informed of these.