What is a credit Policy?
What is a credit Policy?
A credit policy is a document housing a set of decisions or procedures to be considered when extending goods and services on credit. The purpose of the policy is to answer the following questions;
- Who qualifies for credit?
- Terms of credit to be considered
- How to collect from customers
- Recovery steps to be taken in case of default.
A sound credit Policy must be formulated to ensure all benefits of extending goods and services on credit are reaped i.e. increased sales and profits. The policy protects the business from possible defaults.
Factors to Consider When Preparing a Credit Policy
- Business Strategic goals
- competition terms
- Financial needs of the business
- Profit margins to avoid losses due to cost of credit
- Credit objective of the business
- Risk tolerance
- Management sensitivity to credit risk and loss
- Nature of product or service
- Size and nature of the business
Types of Policies
- Libera l Credit Policy- It is a generous type of a policy that allows favorable credit terms to customers. It is necessitated by need for, market penetration, increased market share, stock with short expiry date, stiff competition, high profit margin, low demand and threatened market position by competition.
- Conservative Credit Policy- It is a restrictive policy that is not generous to borrowers and is mainly adopted by businesses that face no or little competition. Condition that may influence this policy are low net profit, high demand for products and services, monopolistic position, established market share, tailor made products, financial position of the company and lengthy production processes.
Contents of the Credit Policy
- Credit mission for the business
- payment terms and condition of credit sales
- Customer credit risk assessment and appraisal
- Collection methods to be used.
- Performance measurement of a credit department
- Recovery procedure of overdue accounts, appointment of third part collectors and legal recovery
- Staff responsibility
- Approval by the board.
Adopting a credit policy in a business ensures all customers are treated equally, breeds consistency in the business, portrays a positive business attitude towards customers, eliminates special terms to customers who are not credit worthy and ensures business continuity.
In conclusion a credit policy is a must have for every type of a business in order to reap full benefits of extending credit.