Why an Internal Credit Policy is Important

In a small company probably one person, either full- or part-time, will be used for credit control duties. He or she might carry out this task with other work. So it is important they understand what is required of them, and the extent of their authority. In larger firms where two or more people are employed in the credit function, clear job descriptions are a must for each employee, to eliminate errors.

Credit reporting

The standard monthly management reports required from the credit manager, and the person to whom he or she must submit their reports, ought to be indicated. Ideally, the credit manager needs to have a direct reporting line to the company’s managing director or chief executive officer. In practice it is usually the finance director or controller, and sometimes the sales director. The reason for reporting via the accounting function is that the credit manager is responsible for:

•             the amount of risk the company will tolerate

•             obtaining payment within terms

•             establishing credit terms for achieving sales targets.

These fundamental objectives make reporting direct to the managing director the preferred route, failing which the credit manager should report via the accountant. In some sales dominated firms the credit department reports to the customer services section.

Dealing with new accounts

A set practice for handling new business should be established. When a new hard-won customer is introduced, you do not want to lose their first valuable order owing to delays in the credit department. It is possible to allow a minimal initial order to be delivered without credit vetting, and exposing yourself to loss. But knowing what information the credit manager requires from the sales department, and vice versa, will speed the processing of new business. New account procedure must be an integral part of your credit policy document.


Issuing credit notes

Credit notes should never be approved or issued unless supported by sufficient written evidence to justify their being raised. A credit note is not simply a book-keeping entry, to be dealt with by anyone. It is comparable to cash or issuing a cheque. Therefore a strict gradation of authorisation must be in operation. Credit notes are for use solely where there has been an error of:

•             overcharging

•             short delivery

•             or other mistake.

Suspending credit

No matter how good your credit management is, there will be times when delinquent customers will force you to withdraw credit facilities and place a stop to further business transactions. The circumstances which can lead to this action must be precisely explained, and who will be responsible for invoking the ‘stop procedures’ must also be stated. If you employ a credit manager, his experience will be your best guide for instigating this procedure.

Acting against bad debts

Defining what constitutes a bad debt should be clarified within your credit policy manual. Is it the amount of debt outstanding, or the length of time an account or invoice remains unpaid? A bad debt must not be confused with an overdue amount. If your trading terms allow for 30 days’ credit, at 31 days the account is overdue. At 60 days from the date of the invoice the debt could be construed as a bad debt. Depending on your policy, an account still outstanding at 60 days could be considered borderline at least, and should be handled very carefully.

Monitoring accounts

Of course, account monitoring is the responsibility of the credit manager or controller. But in a small firm, where it is not feasible to employ this staff, a named employee or manager must be made responsible for managing your sales ledger debt, and reporting on it to you. Also they have a duty to ensure your customers do not exceed their credit limits, and will know when to commence your collection routines.

Finally, it is prudent, especially in times of high inflation, to review credit limits on a periodic basis. There should certainly be no more than twelve months between reviews, and six months is recommended, particularly with your larger customers at times of rapidly increasing inflation, otherwise you could be losing precious orders to your competitors.

Accounting periods

A few companies still use the outdated lunar monthly credit cycle, with two four-week months, followed by a five-week month. This can be confusing to your customers, who have fixed cut off dates. In addition it can distort your debtor reporting figures. The system more generally used and recommended is the calendar monthly accounting cycle.

Anna works for Global Tax Reclaim and writes for their websites and blogs.

Photo source: http://www.flickr.com/photos/atbaker/3358143960/

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