2. Develop sensible credit policies
Credit policy is an essential tool that gives structure to businesses and lays the foundations for profitable trade. By indicating the terms, circumstances, and customers to whom certain amounts of credit should be offered, credit policies walk a fine line between profitability and bad debts.
Internally, implementing clear credit policies helps align various departments, notably credit and sales. During challenging economic times, they can refer to the credit policies and work in tandem on improving margins while mitigating as much credit risk as possible.
Externally, setting explicit credit policies upfront helps manage your customers' expectations about the trade relationships. It brings the much-needed gravitas and transparency to the table when negotiating payments with the customers becomes necessary.
Establishing effective credit policies is an overarching strategy that starts with fundamental aspects like:
- Credit limits. It is crucial to identify the contributory factors to your customers' credit limits. You may run creditworthiness checks on your customers before setting their credit limits. You may devise a credit risk rating system coupled with several tiers of credit limits. Or you may decide on a default credit limit for all of your customers, then raise or lower the limit depending on their payment behaviour. No matter which method you use to set credit limits, you should instate a credit approval process to ensure proper enforcement. More on this in the guideline "3.Establish proper processes" below.
- Credit terms. Besides standard aspects like the payment means and payment periods you expect from your customers, you may want to add specific terms to influence their payment behaviour in favour of your cash flow. Discounts can be offered when the customers opt for down payments or prepayment. Interest charges or late fees can be incurred when the customers delay their payments. Both incentives and disincentives should be in line with your organisation's strategy and have buy-in from sales. When your sales team negotiates these terms with the customers, they become aware of the repercussions of late payment. And by agreeing to the terms and conditions of sale, they make the terms legally enforceable.
Next to that, you may want to cover bad debt management in your credit policies, as the risk of non-payment is prevalent in the food and beverage sector. You can start by planning a course of action for collecting outstanding accounts receivable. This could range from warnings, in-house collections activities, external debt collections partners, to litigation. Then you can discuss the implications of such defaults with sales. This could include reducing the customers' credit limits and tightening their terms. To make sure that your credit policies reflect current market realities, you should regularly get input from your sales team. As market conditions change, it is vital to recognise when you should make exceptions and what kind of exceptions should be made in your credit policies. Under certain conditions, allowing temporary anomalies could prove beneficial to profitability in the long run. Whether it is stretching credit limits or extending credit terms, you may want to weigh margins against increased credit risk together with your sales team. It is important to help them understand that shaping and following credit policies are not impeding sales, but facilitating sales where deals are most likely to turn into cash and not debts.
Once your credit policies are set and documented, you should communicate it to relevant teams and make sure that they adopt it. The credit team should refer to the credit policies whenever the situation calls for it. And the sales team should get approval before making any changes regarding it. Well implemented credit policies will act as the guiding principle behind all decisions regarding credit, helping reduce risk and protect your organisation's margin.