Building a Credit Policy from Scratch

Adhering to a corporate credit policy is essential to managing and assessing credit risk, setting payment terms and ensuring a healthy cash flow. Having a policy in place to follow establishes the guidelines to maintain financial stability and build trust with customers while minimizing the potential for bad debt. Although a credit policy is one of the most important documents in credit management, many credit departments do not have a credit policy set in place. Establishing a sound credit policy empowers the credit department to not only be an asset to the company but also play a key role in fostering long-term financial success.

Credit Policy vs Credit Procedures

A credit policy is a written document approved by top senior-level management that states the underlying framework that defines the company position on credit risk and how the extension of credit will be governed. Credit procedures are the individual steps and processes required to accomplish specific credit department tasks. Credit policy and credit procedures are used to empower the people responsible for the credit process, by providing the direction and consistency they need for successful execution.

A credit policy creates the framework for sound credit decisions. “Following credit procedures to comply with credit policy requirements and guidelines ensures we obtain enough information to make a well-informed and sound credit decision when we establish credit limits and offer open account terms to our customers,” said Brett Hanft, CBA, credit manager at American International Forest Products, LLC (Portland, OR). “A credit policy helps to ensure smart and sound credit decisions are being made, which will help ensure timely payments and consistent cash flow to your business.”

A formal written credit policy should be a constant, practical guide for conducting all processes in a credit and collection function. A policy should be reviewed and updated periodically to align with organizational objectives and changing internal and external conditions.

The purpose and benefits of a written credit policy manual include:

• To identify the credit department’s mission and how it will improve the entire organization’s efficiency.
• To provide guidelines for managing credit procedures.
• To ensure that everyone both internally and externally understands the responsibilities of the credit function.
• To provide a fair and consistent approach to interacting with customers and with other departments to avoid misunderstandings, miscommunications and inconsistencies.
• Decision making becomes a logical function based on pre-determined parameters.

Communicate management’s parameters once credit terms and limits are set with your credit department. “The credit team should be able to consistently obtain enough credit information to determine if the business will support open account terms and a credit limit that doesn’t create unreasonable levels of risk,” Hanft said. “Document what will be required to have a complete credit file.”

A strong credit policy must have a credit department mission statement that expresses the long-range focus of the policy and defines the purpose of the credit department. It should summarize how the credit function will contribute to sales growth and profitability through risk management and customer relationships.

Components of a Credit Policy include:

• Credit department goals
• Organizational roles and responsibilities
• Terms of sale
• Credit evaluation and credit limits
• Monitoring accounts
• Reporting to management
• Budget guidelines
• Timelines and procedures for account evaluations/order approval
• Communication of credit decisions to the customer, (internal) sales, management, operations
• Guidelines for providing assistance, advice to marginal or troubled accounts
• How to address unauthorized discounts, deductions and interest charges
• Credit’s role in terms of sale establishment

Updating an existing credit policy is essential to adapt to changing business environments, economic conditions and industry trends. Regular updates ensure that the policy remains effective in managing credit risk, improving decision-making processes and staying aligned with the needs of the company and its customers. “Every 12 months, we pull new credit reports and request updated bank and trades to review every active account in our portfolio,” Hanft said. “We review sales and payment experience to determine if we see any changes from the previous update: Is the existing credit limit adequate? Can we continue to support the credit limit we have in place? It’s time consuming but necessary to ensure we are not exposed for excessive risk of loss.”

Collaboration with management and other departments is crucial when updating a credit policy. Involving various stakeholders helps gather diverse perspectives and ensure alignment with business goals and objectives. Sam Bell, credit manager at Louisville Ladder Group LLC (Louisville, KY), who attended the 2023 Credit Congress session, The Time is Now to Review and Update Your Credit Policy, said his company’s finance and upper management teams helped with part of the process of revision and approval of their credit policy.

Another session attendee, Brian Newcomb, director of credit strategy and policy at AT&T Inc. (Dallas, TX), recognized the need for optimization and refinement of their credit policy, particularly considering changing industry dynamics. “We involved the finance, sales, marketing and legal teams to ensure that our revised policy aligns with the goals and objectives of each department,” Newcomb said. “They provided diverse perspectives, ultimately leading to a more robust credit policy. Regular policy reviews and updates are important since the credit industry is continually evolving, and staying proactive in adapting our credit policy has proven to be essential for our success.”

The bottom line: A well-established and regularly updated credit policy is essential for managing credit risk, ensuring consistent cash flow and fostering long-term financial success in a company.

Be sure to register for Credit Congress 2024 and attend Hanft’s session on Credit Policy Boot Camp: Creating a Credit Policy from Scratch.