Providing quality goods and services requires a significant investment of time, cash, and expertise, and without an effective credit and collection policy, a reasonable return on that investment may prove elusive. By extending credit to customers who don’t pay, companies all too often provide products and services for free. Yet if businesses tighten credit requirements too much, good customers may take their business elsewhere. Although owners and managers may be reluctant to pump scarce resources into collecting bad debts, if receivables aren’t adequately controlled, a company may find itself without the cash needed to cover ongoing expenses.
All things considered, developing and maintaining a strong credit and collection policy is a balancing act. Nevertheless, every policy should include certain key elements.
- A mission statement and goals. Will you be liberal on credit and conservative on collections, or vice versa? How much risk are you willing to accept? How will you measure the effectiveness of your policies? To track goals, some companies use various metrics — the percentage of current receivables to sales is one measure — to determine how well their credit and collection policies are working. A strong policy will spell out these goals and metrics.
- Departmental responsibilities. The policy should define specific roles and levels of authority for credit and collections staff. It should delineate who is responsible for collecting required customer documentation and who has the authority to establish and revise credit limits. The policy also should discuss the chain of command and specify who has the final word when conflicts arise.
- Credit evaluation and approval processes. A strong policy will lay out procedures for extending credit, such as stating that customers with credit limits below $5,000 will not be scored for new orders, but those with limits between $5,000 and $10,000 will require a current credit report. The policy also might require that orders exceeding certain limits be accompanied by a current set of financial statements.
- Systematic collection procedures. You’ll want to document when and how delinquent customers should be contacted. The policy and procedures manual might include phone scripts, sample collection letters, and a discussion about turning over delinquent accounts to third-party agencies. Some surveys show that the probability of collecting past-due accounts drops to 50% after six months and 25% after a year. Accordingly, your policy should also discuss the write-off of uncollectible accounts.
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