Developing a Credit Policy Framework

A credit policy is a set of guidelines that:

• are used to determine which customers are extended credit and billed
• set the payment terms for parties to whom credit is extended
• define the limits to be set on outstanding credit accounts
• outline the steps or procedures used to deal with delinquent accounts.

A credit policy is an encapsulation of how risk-averse a company is regarding the extension of credit.

A Credit and Collections Process Framework

Streamlining the entire end-to-end process of assigning credit and collecting receivable can be effectively guided by a 5-point credit and collections framework. It consists of the following 5 processes:

1. Establishing a credit policy is the stepping stone to develop a successful credit and collections framework. It should clearly define the roles and responsibilities of each A/R member and how to find the accurate creditworthiness of a customer.
2. This framework also encourages executives to use reporting and data analytics to measure the success of their processes and spot trends for further strategic planning.
3. Developing a robust collections strategy helps to target essential accounts based on risk level while investing only the minimum required resources for the task.
4. It is equally essential to document all the collection efforts while dunning the customer.
5. It is customary to fight for your dollars, but this should not be at the cost of customer experience. Therefore, it is imperative to negotiate with the customer before taking any legal action.

What To Have In Your Credit Policy ?

Evidence of a Debt

1. Contracts signed by both parties agreeing to the payments.
2. Canceled checks of previous payments.
3. Emails that indicate concession of a debt.
4. Purchase orders showing the amount owed.
5. Invoices previously submitted for the debt.
6. Account statements showing payment history or lack thereof.
7. Any other relevant documents that demonstrate the existence and nature of the debt.

Developing a Credit Policy Framework

1. Mission Statement of the Credit Department

• To support the financial goals of [company] and, specifically, to support its sales efforts, while maintaining the highest quality of accounts receivable within the corporation?s capacity for risk.
• To provide flexible mechanisms to sell to a broad range of customers while ensuring that only prudent credit risks are taken and cash flow is maintained.
• To maintain customer goodwill during the collection process.
• To keep the sales team and senior management informed about emerging problems including credit holds and uncollectible accounts.

2. Credit Department Goals

• Establish a target for the percentage of bad debts to sales.
• Sets targets for acceptable account aging, i.e. % current, average days delinquent, percentage over 90 days past due.

3. Roles & Responsibilities and Authorization Levels

Setting authorization levels for all A/R managers, analysts, and executives is an integral part of the credit policy. Although they differ from company to company, some common examples of roles and responsibilities of different A/R leaders are:

• CFO ? Ultimate authority for Credit Department; hires/fires, sets overall policy.
• Credit Director/Manager ? Reports to the CFO. Plans organize, leads and controls the credit function. Responsible for day-to-day management and training of the credit staff, determine procedures and rules for the entire department, authorize credit limits over $500.00. Selects outside collection agencies and/or outsourcing firms with the approval of the CFO.
• Billing/Invoicing Manager ? Reports to the Credit Manager. Responsible for the day-to-day management and training of the personnel within the Billing Department, maintaining high standards of invoice accuracy, handling invoicing disputes, deductions, and all matters pertaining to billing. Reviews the daily aging report.
• Collections Manager ? Reports to the Credit Manager. Responsible for the day-to-day management and training of the in-house collection team. Coordinates with outside collection agencies. Authorizes payment terms with the approval of the Credit Director.
• Credit Analyst ? Reports to the Credit Manager. Obtains and analyzes financials, analyzes credit reports for clients requesting credit limits of more than $500, assigns credit limits up to $250.00.
• Billing Clerk ? Reports to the Billing Manager. Responsible for preparing the invoices and ensuring that they are sent on time, maintains the aging report, provide other support services to the Billing Manager as required.
• Collection Specialist ? Reports to the Collections Manager. Contact past due accounts per requirements. Accepts payment terms with the approval of the Collections Manager. Maintains records in the collection system.
• Credit and Collection Assistant ? Obtains signed credit applications, reviews for completeness. Requests credit references and follow up. Pulls credit reports. Provides other support functions as needed.

4. Pre-defined Procedures

Strategic planning for all basic tasks, including assigning credit limits and implementing a dunning strategy, still plays a crucial role in the A/R space. Therefore, it should be part of the credit policy.

4.1 Procedures ? Determine New Customer Credit Worthiness (Example)

Table 1 shows a strategic plan on how to determine the creditworthiness of a new customer based on :

• Requested credit limit
• Credit application completed and signed
• Verification from check references
• Data obtained credit report
• What to set as initial terms
• What should be the assigned credit limit
• Who will give the approval

4.2 Procedures ? Establish Collections Process (Net 30 Terms Example)

Table 2 describes three different portfolios of customers and the correspondence approach that could be followed based on Aging and due amount. The sample table uses the following set of simple steps to select the dunning strategy:

• If the amount is high ($5000+) or ($2500- $5000), then regular reminders and follow ups are done even before the invoice is due. It is then escalated to the manager who can then approve sending the final demand notice and forwarding to a 3rd party.
• If the amount is between $500-$2500, the dunning is followed up internally and it is forwarded to 3rd party only when the invoice is 70+ days past due.
• If the amount is <$500, a few follow-ups are done and then the credit limit is put on hold and a demand letter is sent.

5. Measuring Results ? Implement a Scorecard

After finalizing the mission statement, credit goals, and the roles and responsibilities of A/R workforceand setting up the strategic procedures for all essential processes, now it is time to measure your results! Here is a to-do list that every credit and A/R leader must follow to get the most accurate measurement of its accounts receivable:

1. Start with your aging analysis and the metrics identified.
2. Look at the impact your credit policy has on sales and cash reserves.
3. Revise your credit policy-based results.

Just three steps and you are ready with a revised credit policy that will give you better results. However, there is another common question here: What metrics should I use? Here are the metrics that should be tracked while making a monthly collection of individual performance scorecard :

• Aging and/or tracking monthly dollar objectives or goals.
• Dollars collected expressed in total dollars collected and/or using a comparative DSO.
• Aging, not only of the collector’s unit but how long has the collector had the account, including how many calls, emails, and letters have been used to qualify the customer’s intentions.
• Has the collector secured a promise of full payment or a reasonable payment plan?
• Are there any items in dispute and can a settlement or adjustment be reached?
• Recovery Rates – The dollar amounts collected divided by the total amount in each unit’s inventory.
• Number of calls per day, week, or month.
• Telephone monitoring – Is the collector abiding by all State and Federal laws?
• Account Audits – Have calls been made when necessary and results and comments entered into the system?