Credit and collection policies are tied closely to sales and, of course, owners tend to view making sales as paramount. Many small businesses make the mistake of putting off developing credit and collections policies until they have a problem with an overdue account or available cash.

Before developing a policy, examine your business goals. You may want to limit the number of customers to whom credit should be extended based on the frequency or volume of their orders and payment history. If your business has serious cash flow problems, you may not want to extend credit at all. As well, you will want to ensure your collection processes generate the results you hope to achieve.

Consider the following before setting your Credit Policy:

• Why do I want to extend credit?
• What do I want to achieve by extending credit?
• What costs are associated with the policy in terms of cash tied up?
• Is my business such that I even need to extend credit?

Credit policies should be directed toward some business goals. You cannot set rational credit objectives unless you know where your business is headed.

Remember, credit is the same as having your business extend an unsecured loan to its customers. Ask yourself if you can afford to extend such credit. Avoid borrowing from the bank and paying interest to support cash flow shortages caused by slow-paying customers, as this is bound to cause you further serious cash problems.

Before you extend credit to your customers, you need to know how much your business can realistically afford. The answer to this will depend on your cash flow. If you have enough cash flow to support your business or a surplus, you may want to relax your credit policy, which will translate into higher Receivables. On the other hand, if you are constantly in a cash crunch, a strict policy should be considered.

Think of a Credit Policy as your way of making your customers pay you when you want them to. Again, how you set it up should depend on your cash flow as well as what’s normal for your industry and your own business objectives.

Factors to consider:

• Research what is normal for your industry. This can be your yardstick.
• The better you know your customers, the more likely you are to offer them credit.
• The bigger your customers, the greater the potential for them to dictate a credit policy that ties up large chunks of your cash, or significantly hurts your business if the customer fails to pay.
• How is your cash position? The stronger it is, the better your ability to support a credit policy.

This blog is an excerpt from WeBC’s Financial Workbook for Small Business, available for download at go.we-bc.ca/LearningGuides

Other Resources to Further Your Financial Knowledge

“Financial Fitness” is one of our most popular training series, and now it’s available On-Demand! Part of our SMART Program series, these courses are designed to help you understand key concepts, work through interactive case studies and complete activities that apply the learning to your own business. “Financial Fitness” also includes a whole chapter on Credit and Collections! Learn more >>>[1] 

Link to smart finfit