The use of credit cards and other automated payment systems that allow the customer to conveniently make purchases on credit makes it much easier to sell your goods and services. In particular, offering payment terms such as zero percent interest for credit card purchases can attract new customers, which of course can boost sales and lead to bigger profits.
But to do good business through customer credit, it is very important to maintain a strong cash position to finance it. So, before deciding to tie up your company\\\'s cash in customer collectibles, it would be wise to first create a credit policy and a realistic, doable set of procedures for giving credit and collecting payments. This will give you a better control of your cash flow.
A credit policy is simply a set of rules and procedures that you need to apply to all customers in every foreseeable situation. In a credit policy, you normally need to decide on the following major credit aspects: the maximum amount of credit you are willing to extend to a customer, the terms of payment (whether 30 days, 60 days, 90 days, or longer), the down payment required, and the credit evaluation criteria for new customers. You also need to include in the policy how to go about notifying customers who have past due accounts, and how to write off account receivables that you have already considered as bad debts or un-collectibles. When planning your credit policy, it is advisable to consult your accountant or business advisor for insights and advice on how to best reduce your company’s credit exposure.
The next step is to determine how much cash reserve you can afford to finance your credit sales. This is important because your cash is part of your working capital, and you need to always have enough cash for your inventory purchases and overhead expenses. For this reason, over-investing in receivables may result in imbalances in your working capital, which could force you to borrow money to finance your inventory replenishment and operations. Your accountant can advise you on the maximum credit that you can extend per customer.
When you sell on credit, there’s also the risk of late payments or even non-payment, which could impact on the price of their goods and services. These should be budgeted in the costing, perhaps as a percentage of selling price or of the average receivable balance; the specific percentages will depend on the nature of the business. The other issue that you need to establish is the cutoff for charging interest on late payments and how much that interest should be. You should plan this carefully based on the historical performance of your collection efforts or based on the advice of your business consultant.
Once you have finished writing your credit policy, you will need to methodically and consistently implement it in your business. This process should start with an evaluation of the risk profile of every new customer. You may need to require references, specifically the creditors that your customer has dealt with in the past. A prospective customer’s payment pattern history normally can provide good information about his or her attitude in paying. Does the customer normally pay in cash or by installment? Are there any other issues about the customer regarding his dealings with suppliers? Have there been any legal proceedings in the past against the customer about non-payment? Past business transactions can’t guarantee the future, of course, but the information helps in making a fair evaluation of your customers before deciding to extend financial credit to them.