Setting a Credit Limit Guideline for Customers
Small companies often offer credit to customers without considering the process as more than a necessity of doing business. But when the health of a small business relies on customer payment of the amounts owed, collecting accounts receivable can become a serious issue. A strong, formal credit policy can help set billing guidelines at the initial stage of a sale and may prevent more work and risk after the sale is completed.
The Importance of Credit Guidelines
Establishing an effective credit policy prevents small businesses from over-extending credit to customers and may help them avoid having to devote future time and money managing accounts receivable and collections. Aside from setting a basic credit limit, credit policies should define payment terms, including any required deposits prior to the start of work. Procedures for evaluating a customer's ability to pay should also be a part of credit guidelines.
Credit Policies as Part of Overall Company Strategy
Small businesses' credit policies should take into consideration the overall company strategy, including cash flow management and sales. Smaller companies often need immediate cash to continue operations and cannot afford large extensions of credit to individual customers. Alternatively, to achieve sales targets, companies may need to issue a certain percentage of credit sales.
Just the act of sitting down and listing out formal credit policies is beneficial to small companies as if forces management to outline appropriate actions that should be taken prior to approving credit sales. Procedures can be set for employees to follow when setting up a new account or when selling to existing customers who request higher credit limits. When a large credit request comes in from either a new or existing customer, employees should know when to escalate the approval process.
Small businesses should set credit limits for their customers that allow them to build a long-term relationship. A lower initial credit limit may be set for each individual customer. As a level of comfort is reached for both parties, the credit limit may be increased appropriately. If some type of evaluation is done prior to extending credit, guidelines should include the scope of the evaluation. For example, credit reports may be requested, along with business references or relevant financial data, all of which may help support a final decision.
A credit policy should balance a company's cash flow needs, sales targets and the relative expense of A/R management. Late payments from customers are one key indicator of the performance of a credit policy and may be tracked using an online accounting system.