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Credit Policies and Procedures to Protect Your Business

credit policies and procedures

Would you like to provide loans to people you didn’t know very well? It doesn’t sound too wise, but many businesses are in the finance business by default. In effect, when you offer invoice payment terms to your customers, you're providing short-term loans to them. Companies that don't have sound credit policies and procedures are assuming unnecessary risks and can jeopardise their existence. Here we’ll look at ways to minimise your risk with credit policies and procedures.

Sales on credit can come with a high cost

Credit policies and procedures are often overlooked. Although sales are the lifeblood of business, many companies closely focus on sales and overlook the creditworthiness of their customers when providing invoice payment terms. Even if customers eventually pay, but pay late, it causes cash flow problems and a lot of stress for business owners and managers. 

Compared to other countries, Australia is notorious for late payments to businesses. This is backed by a study that compared payments to businesses around the globe. It found that Australian businesses were being paid 26.4 days later than the traditional payment period of 30 days. In comparison, the next countries for late payments were Mexico and South Africa with the average lateness of 18.6 days and 16.5 days, respectively. The 26.4-day tardiness of payments means that Australian companies are waiting 56.4 days, on average, from the invoice date to be paid. Some accountants state that the accumulated number of debtor days outstanding is a ‘silent killer’ of businesses. When you add in ‘bad debt’ that’s never paid, the problem is even worse. How can this silent business killer be stopped?

Starting out right with credit policies and procedures

To prevent cash flow problems, it’s vital that your company has sound credit policies and procedures to ensure that your customers will be able to pay you when their accounts are due.

Sound credit policies begin with the parameters for how you will deal with granting credit and what happens afterwards when customers are late or do not pay at all. The type of topics a credit policy should cover include:

  • When will a credit application be required?
  • Will you check references and the company’s credit report?
  • What are the standard terms of sale?
  • Is there a minimum time in business before you will grant a customer credit?
  • Is the business in a high-risk industry?
  • Will exceptions to terms of sale be allowed?
  • Who can guarantee/sign the credit application?
  • How will credit limits be set and when can they be exceeded?
  • When will a late customer be excluded from receiving more products or services?
  • How frequently will customers be contacted about overdue balances?
  • At what point will an account be turned over to a collection agency?

The credit application as the first step in credit policies and procedures

A credit application is a type of agreement that sets the credit terms if a customer is approved. The terms of the credit application are based on the policies you have set and should cover all possible scenarios. Some of the basics a credit application should include are:

  • Contact details of the applicant
  • Business structure
  • ABN
  • Details of directors, partners, owners and/or trustees
  • Signature confirming the signer has read the terms and conditions and agrees to abide by them
  • Contact details of at least three suppliers who are willing to act as references
  • Permission to conduct a credit check.

To reduce late and non-payments, make it clear that you will charge interest for late payments and make customers pay any collection fees incurred. An effective application will ask the customer for trade credit references and permission to seek information from these references and credit reporting agencies. If you don’t have one, you will want to select a collection agency that you can call.

Once the completed credit application is received, you can follow up by calling the customer’s references to determine if they have been reliable in paying their debts. For a nominal fee, you can get a credit report that shows negative claims or legal judgements against the customer. If you get warning signs that the customer will have trouble paying, you might want to deny credit or get a substantial deposit before supplying goods or services.

You will want to create creditworthiness criteria as part of your credit policy. If you can find them, you will want to consider your competitors’ credit terms to stay competitive.

Retain title over the products sold until invoices are paid

If you sell products, it’s recommended that you include a retention of title clause in the agreement. This states that you retain ownership of the goods until the invoice has been paid, even if they have been delivered. For companies using this clause, there is a national register where they can document their interest in the goods.

Known as the Personal Property Security Register (PPSR), it enables businesses to register their interest in goods to protect themselves. For example, if a company goes bankrupt and holds products that it hasn’t paid for yet, the company that is owed money is protected if it has registered the goods. By documenting its interest beforehand, it will have priority over other creditors who are seeking funds from the liquidation of assets. Find out more about the PPSR

Make it easy for customers to pay you by getting the right information

The credit application should ask the customer where and to whom the invoice should be sent.  Payment delays are often the result of the invoice being sent to the wrong person or wrong location. Also, give customers as many as options as possible to pay, such as by cheque, bank transfer, credit card and PayPal.

It’s essential that you send invoices immediately after your product or service has been delivered. Delaying invoicing sends the wrong message to your customers if you delay invoicing, some might believe they can delay paying you.

Follow up on your receivables

This is where your credit procedures come in. If you don’t receive payment by the due date, follow up immediately with a phone call. Make sure the right person has received the invoice and ask why the invoice hasn’t been paid. Ask for a firm commitment date to get your payment and keep in regular contact until the payment has been made. When it comes to collecting receivables, the company that stays in regular contact is likely to get paid faster than others.

When a customer isn’t responding to requests for payment, it’s time to call a collections agency. Most operate in a commission basis and receive a portion of what they collect. They will make phone calls and send demand letters on your behalf. If they aren’t successful, they will then discuss other options such as taking legal action.

Avoid unnecessary risk be establishing credit policies and procedures

Remember that by offering credit your company is in the lending business by default. Establishing and adhering to effective credit policies and procedures will reduce the risk, stress and cash flow problems that can occur when extending credit.

Consider business finance to solve cash flow shortages

Even if you implement credit policies and procedures, slow payers can cause cash flow problems. Some businesses use short-term business loans to overcome this challenge. If you are considering this option, check out our business loan calculator for an estimate of principal and interest repayments.


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