A credit policy contains guidelines that structure the amount of credit granted to customers, as well as how collections are to be conducted for delinquent accounts. The policy is an essential element of the finances of a business, since it impacts the amount of working capital required to support accounts receivable, and also influences the amount of bad debt losses. A credit policy typically addresses the following topics:
- Credit terms. It covers the normal payment terms that the company will allow to its customers, and the circumstances under which alternative terms are allowed. This section may include early payment discounts. Alternatively, it may include requirements for payments in advance, which is especially common for custom orders.
- Credit limits. It states the amount of credit that will be allowed to customers, given certain criteria. For example, a new customer may automatically be granted a $500 credit limit, while a payment history must be proven and financial statements issued before credit can exceed $5,000.
- Information requirements. It identifies the information that must be received before credit will be granted, such as a credit application, personal guarantee, credit report, and financial statements.
- Collection progression. It states the order in which the collection staff will engage in collection activities, perhaps beginning with notification calls or dunning letters, and progressing through collection agencies and legal action.
The credit policy is adjusted to match company strategy, as well as to reflect changes in economic conditions. Thus, a strategy to rapidly expand sales might call for a change in the credit policy to allow more credit to customers, while a decline in economic conditions might lead to a restriction in the credit policy in order to guard against an increase in bad debt expenses.