Credit Policy Part 2

Last month I explained that your credit policy is there to increase your sales, not reduce them. However, you need to make allowances for different types of customers, i.e. low risk, medium risk and high risk. Not all customers are the same and you should treat these three groups of customers differently.

<--break->Your credit policy must be in place before you grant credit to a business, individual, government department or other entity.

Apart from your procedures to collecting overdue accounts, (This is a topic for another time.), you need a policy on when you plan to withdraw credit. Firstly, let’s look at when you should not withdraw credit. You should not withdraw credit the first time an account is overdue. Nor should you threaten to withdraw credit. Also, you are unlikely to withdraw credit on the second reminder or even as a third reminder.

Let’s go back to the goal of your credit policy. Your goal as a credit manager is to maximise your sales. Keep in mind that a sale is not a sale until the goods or services have been paid for. So what is the logic in withdrawing credit just because an account is overdue, even if three reminders have not resulted in payment? It is important that you do not allow your ego to get in the way. Do not be frustrated with slow payers. Do not try and punish them for being slow. Instead, take a step back and look at the problem logically.

I have listed three reasons below for withdrawing or threatening to withdraw credit. One of the golden rules of credit management is if you make a threat you must be prepared to carry it out.

  1. After speaking with your customer, you feel the best chance of receiving prompt payment is to threaten to withdraw credit facilities to this customer.
  2. Continuing to offer credit to this customer is considerably reducing the profitability of your business.
  3. Continuing to offer credit to this customer is threatening the solvency of your business.

The withdrawal of credit facilities or the threat to do could be interpreted as suggesting to your customer that you no longer value their business and don’t mind if you take their business elsewhere. This is a very serious matter. This is why it is important to go back to the original goal of the credit manager. It is to maximise sales. If your customer needs to buy your goods or services on credit and you are withdrawing this privilege, then you are risking the loss of this customer.

A skilful credit manager does not want a database full of customers who pay their account on time always. If it does, it means you are being too strict on offering credit in the first place. Instead, your business should have a mixture of late payers, slow payers and customers where it is challenging to collect your money. If all your customers paid on time or proved very easy to collect from, then the chances are that you do not have enough sales.

Of course, there is one obvious drawback to withdrawing credit facilities. Your customer may not be a regular buyer. The withdrawal of credit facilities has no impact on the customer who makes one-off or irregular purchases.

The next thing to consider is who has the stronger bargaining power. In other words, do you need your customer more badly then they need you? In this case, it is unwise to withdraw credit. Suppose you are a small business supplying your product to a large department store or retailer or even a government department. It is really an idle threat to withdraw credit because the large company or government department may simply decide to get a similar product from someone else. Instead, you are better off using skilful persuasion rather than threats of withdrawing credit.

However, if your customer relies on you to provide regular products or services to their business, then a withdrawal of credit will really inconvenience this business. In these circumstances, such a threat is very powerful.

This situation is the main time that you would threaten to withdraw credit. However, you can do this more regularly if the slow payments really have a substantial effect on the profitability or even the solvency of your business. It is hoped that this is not a problem for your business.

One situation I have deliberately overlooked to this point is the issue of credit limits. These are useful for individuals with a credit card but for profitable businesses, I cannot support the notion of credit limits. A credit limit is simply a sales limit. You are saying to your customer that you do not want them buying too much from you. The more your customer buys, the more risky they become but they still should be able to buy your goods on credit. You may have to adjust the conditions for larger purchases or as purchases become more frequent.

Having said that, if you have a credit limit and your customer goes over it, by all means withdraw further credit until payment are made to reduce the amount owing below their credit limit.

One of the most important parts of any credit policy is if and when to take legal action. This is a topic for next time.

Ref: Small BIZ Tips Volume 3 Issue 5 by Ian Renton March 2010

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