Understanding Credit Policies for Small Businesses

Managing the financial sustainability of your entity comes with a bunch of responsibilities including having credit policies for small businesses in place. To ensure your company is growing, you have to keep a close eye on your cash flow at all times. Issuing invoices is easy enough but checking that payments are done on time is another story altogether!

Credit management is key to the success of any small business and needs to happen from the day you start operating. Having a credit policy for small business purposes means you’re taking the financial obligations of your organization seriously. This is one document every startup should have in place before opening for business.

But what is credit management? And how does a credit policy help you as a small business owner? Read on as we talk about credit control and how to manage it so your company’s earnings are well-protected and your cash flow remains healthy even through difficult times.

What is Credit Management for Small Businesses?

For an enterprise to thrive they need to have good credit management. This is the process by which credit terms are granted to customers with clearly defined payment terms. A good credit manager will always try to minimize any risk while still maximizing potential opportunities for a sale.

Trading on credit is a popular practice in the B2B environment. Offering credit to customers means you’re extending trust towards building a good business relationship with them. Operating on credit is an essential business tool many companies use to foster long-term relationships with their clients. However, if it’s not well-managed it can become a cash flow problem for you.

Credit control is a fine balancing act. It requires mitigating any potential risks while determining exactly what length of credit term you should extend to a customer. The longer the credit term, the more you’ll feel the impact of non-payment on your cash flow.

What is Credit Policies for Small Businesses?

Credit policies for small businesses refer to the guidelines and procedures established by a company regarding the extension of credit to customers. These policies typically include criteria for assessing customers’ creditworthiness, setting credit limits, determining payment terms, and managing collections. They are essential for managing cash flow, reducing financial risks, and ensuring the overall financial health of the business.

Good credit control means you’re minimizing the time you have to wait for payment once you’ve supplied your customer with goods or services. A credit policy gives you clear and concise guidelines on what credit to extend to your customers and what type of payment terms to offer. This document also describes the process to undertake when offering credit to a customer.

Why Small Businesses Need a Credit Management Policy

A credit policy for small business purposes means you can offer credit in a controlled manner. This way, you’re extending credit while leaving no doubt in your customer’s minds as to when you expect them to pay. Clearly stipulated Payment terms can include conditions such as late settlement fees, due date, and method of paying.

When you implement credit control procedures from the start, you’re not only issuing professional invoices on time but you’re handling receipt of payments in a controlled way. This prevents wasting time chasing up outstanding payments. Credit policies also help you to plan your cash flow and calculate what your business can afford to float financially when offering payment terms.

How To Create Credit Policies

Developing robust credit policies is paramount for businesses to manage financial risk effectively while facilitating growth and maintaining liquidity. Here are several key steps to consider when creating comprehensive credit policies:

1. Strategic Alignment:
   Initiate the process by aligning credit policy objectives with broader organizational goals and risk management strategies. This ensures that credit policies are tailored to support the company’s overarching financial objectives and risk tolerance levels.
2. Risk Assessment:
   Conduct a thorough assessment of credit-related risks, encompassing factors such as customer creditworthiness, market volatility, and industry-specific challenges. By identifying potential risks early on, businesses can proactively mitigate them through targeted policy measures, including credit protection strategies.
3. Criteria Establishment:
   Define clear and concise criteria for extending credit, encompassing parameters such as credit limits, payment terms, and creditworthiness thresholds. These criteria should be grounded in data-driven analysis and tailored to the specific needs and risk profile of the business.
4. Approval Processes:
   Establish structured approval processes for credit applications, delineating roles and responsibilities across departments. Implementing clear approval workflows ensures consistency, transparency, and accountability in credit decision-making.
5. Monitoring and Review:
   Implement robust monitoring mechanisms to track the performance of credit policies over time. Regular reviews allow businesses to assess policy effectiveness, identify areas for improvement, and adapt to evolving market dynamics and regulatory requirements.

By following these steps, businesses can develop credit policies that strike the right balance between risk management and growth objectives, enabling them to navigate the complexities of the credit landscape with confidence and agility.

6 Steps to Implementing a Credit Control Process

The number one benefit of having a credit control policy in place is that it defines the process, step-by-step, when offering credit terms to a customer. A good credit manager would ensure that the sales team is fully clued up on this process. And, if you’re a one-man show, you as the business owner, will be able to offer credit terms knowing that you’ve gone through the process beforehand.

Following the credit control process minimizes any risk of getting non-payment or taking on slow payers. It also gives you guidance when you think you’re dealing with a con artist trying to take your business for a ride!

Step #1: Get to Know Your Customer

Getting to know your customer is the vital key to successful credit policies. This knowledge helps you in deciding whether you extend credit or not. If you miss this step out, you’re already in murky waters when it comes to proper credit management! Find out everything you can about your potential customer. Relevant information can be captured by asking your customer to fill in an application form for credit terms.

This application form will give you all the details you need to perform a credit check. It gives you permission to get a full credit report on your potential client and a full indication of their payment behavior with other lenders.

Step #2: Set Realistic Credit Terms

When you have all the necessary information about your customer obtained through Step #1, you’re better placed to decide on realistic credit terms. This is another important part of credit policies for any business. You’ll be able to determine how much time you can afford to give your client and the type of payment terms you’re willing to offer them.

These credit terms need to be fully detailed and formalized so there’s no dispute further down the line when it comes to making payments. Ensure your customer understands the terms you’re extending them and get their full agreement before you deliver goods or services.

Step #3: Be Clear About Your Debt Collection Process

A good credit management policy should include a debt collection process. Having this clearly spelled out makes it easier for your administration and sales team members to inform potential clients what will happen if there’s late or no payment.

Details for debt collection make it easier for your company to follow through when a customer defaults on their credit terms. At no time should a small business owner feel they can’t claim on debts outstanding to them.

Step #4: Be Prompt With Your Invoicing

No customer will take your business seriously if you don’t issue professional invoices promptly. When you’ve made a sale, make it your priority to issue an invoice. This way, your customer is reminded of their credit and payment terms which should always be clearly stated on your invoices.

Automated invoicing software keeps you ahead of the game when it comes to issuing invoices. You can have peace of mind the invoice is mailed directly to your customer’s inbox and it’s easier to track all payments received.

Step #5: Keep It Simple

Nowadays, more companies are switching over to automated invoicing systems. These systems simplify the whole process of credit management making it easier for you to issue invoices and receive payments faster, or at least, on time.

A credit control policy would encourage you to install an online invoice generator so you can send out simple invoices that include all the information your customer needs. You could also include a pay button that allows your customer to make online payments, quickly and simply.

Step #6: Thank Your Customers for Payment

The sixth step in implementing functional credit policies is to always follow through on payments made and thank your customers when they’ve paid your invoice. This step ensures you grow a good relationship with your customer and encourages them to come back to you for more business.

When a client honors your credit terms, you want to keep them on your books. Nurturing business relationships with good payers means you can be sure they’ll prioritize your company. And, you can rest assured payments on future sales will always be honored.

What problems come with bad credit management?

Poor credit management often leads to a business becoming bankrupt. This is one of the main factors leading to startups failing soon after starting their own enterprise. New small business owners are so keen to build potential clients that they’ll willingly offer credit without taking into consideration the pitfalls of such practice.

Without having a clear credit control policy in place from day one, you’re already exposing yourself to poor money management. A credit policy for small business purposes can prevent the following dangers from happening:

• Bad management of accounts receivable leads to less capital for the business to invest back into the company.
• Higher risk of taking on slow payers which means payments are always delayed for longer than the business can afford to carry.
• Exposure to fraudsters taking advantage of your credit terms to exploit you and your business.
• Poor monitoring and evaluation of your cash flow on a regular basis.

To avoid the dangers of poor credit management, it’s essential to have credit policies in place.

What are the types of credit policies in small businesses?

Credit policies vary based on their degree of leniency or strictness in extending credit and managing risks, adapting to firm-level goals and market conditions.

The American Bar Association report on credit conditions offers valuable insights into prevailing credit policy orientations, encompassing various types of credit policies.

• Loose credit:
  

  Characterized by a strong willingness to extend credit, aiming to fuel business growth despite higher risk levels. Examples include granting credit to below-average credit profiles with limited access to capital or weaker financial capacities.

• Tight credit:

  Reflects a reduced inclination to extend credit to support revenue growth, focusing on minimizing losses and bolstering capital. Typically reserved for above-average credit risks with superior financial capacities.

• No credit:

  Indicates a reluctance to extend credit, driven by risk aversion or lack of business justification. Examples include cash-only transactions or businesses with insufficient capital for trade credit.

• Flexible credit:

  Adapts credit extension based on circumstances, maintaining a balanced approach without excessive expansion or restriction. It involves granting credit to a broader range of average credit profiles, with provisions for exceptional cases.

Common Mistakes You Can Avoid With a Credit Policy

Poor credit management leads to trouble and if you don’t have a credit policy in place, you could end up facing the following common mistakes most small business owners make:

• Poor customer relationships: The simple act of not saying thank you for payment can make a customer feel ignored or disrespected. Poorly designed invoices can also frustrate your clients leading to slower payments leaving you feeling resentment towards your customer.
• Aggressive chasing of payments: The last thing you want to do is get aggressive with your customers because of slow payments. However, this is what often happens when you don’t have a clear credit policy to guide you on how to set credit and payment terms properly.
• Slow invoicing: You can only expect payment when an invoice has been issued. When you’re slow in issuing invoices, your cash flow will take a knock as you wait for the money to come in.
• Poor debt collection: When the debt collection process is not clearly defined for both the business owner and the client, it makes it harder to collect on outstanding payments. Instead, many companies choose to ignore late payments rather than face the client and come to an agreement that’s amicable for all parties involved.

By setting up a proper credit policy right at the beginning of opening your small business, you can avoid all of the common mistakes mentioned above.

Why is it important to have a documented credit policy?

Having a documented credit policy is important because it provides clear guidelines for managing credit within your business. This helps ensure consistency in decision-making, reduces the risk of errors or misunderstandings, and promotes accountability.

Pro tip: Documented policies also serve as valuable references for training new employees and can be used to demonstrate compliance with regulatory requirements.

What are some examples of credit policies?

You can easily find credit policy examples on the internet. If you have an accountant or bookkeeper managing your financial systems, ask them to set up a credit policy. If they’re not sure how to do this, they can find free templates online.

Here is a breakdown of a credit policy example for you to use for your own small business. It’s made up of the following components:

The Purpose of the Credit Policy

The purpose of the credit policy should be clearly defined. This could include a statement such as the following:

“This credit policy offers clear guidelines outlining the requirements for terms of payment with the entity’s clients. These guidelines stipulate the process through which credit may be offered as well as how to monitor payments. This policy also stipulates payment terms for customers who don’t qualify for credit with the entity.”

The Scope of the Credit Policy

This component of the credit policy states the sales it’s applied to. The policy will define to whom, and within which country or location, sales are made. It also clearly states the types of contracts the small business can fulfill or perform.

The Main Body of the Credit Policy

The main body of the credit policy should include the following statements:

• Which customers may be granted credit terms.
• The amount of credit granted.
• The number of days within a payment must be made.
• Reviewing the customer’s application form for awarding and adjusting credit levels.
• Who is responsible for offering or adjusting credit terms such as the credit manager or the business owner.

Make sure you cover all aspects of credit control so there are no grey areas when it comes to granting payment terms to potential clients.

Final Thoughts

Proper credit management is the key to running a successful and financially viable small business. By ensuring you have a solid credit control policy in place from the day you open your enterprise, you can rest assured your cash flow will stay on track.

If you need support in managing your invoicing process check out our Billdu website to find out more about our automated invoicing platform for small enterprises. Proper invoice management is also key to good credit control practices so make sure your invoicing systems are fully automated for a smoother process.