Creating a Credit Policy that Helps You Get Paid

By Candace Pavliscak, Chief Credit Officer & Senior Vice President, Hennessey Capital

Everyone thinks of the banking/finance industry when they hear the term “credit policy” particularly with the prevalent coverage in the media as of late. I have even seen “lending policy” and “credit policy’ used synonymously in some articles but I believe what they each represent is very different. While it is true that all financial institutions have a credit policy that drives their lending practices (some better than others as we have seen), every business should have some form of credit policy.

Why should your company have a credit policy? Think about it, as a goods or service provider you are extending credit to every customer that doesn’t pay you cash on the spot for your work. You should have some idea of how much credit you are willing to extend and to whom. The basics of a credit policy can be summarized as follows:

Know your customer. How well do you truly know your clients? What reputation do they have around town or among industry peers? What are their typical payment habits? Is there an end user beyond your customer that will affect payment to you? If so, how strong is that company? It is a recommended practice to request credit references and utilize public data to analyze your customers before you begin a relationship.

Know yourself. You need to be able to determine how much risk you are willing to take? This boils down to how much are you willing to lose. As we see with personal investors, some are willing to take big risks for the possibility of larger returns and others prefer smaller returns and limited risk. Find the balance that suits your business. Remember though that no one collects 100% from all its customers 100% of the time. Also be aware of how many “good sales” you have to generate to make up for the one “bad sale.”

Have a process and make sure it is communicated to all employees. This principle encompasses everything from your sales process (do your sales people understand your risk tolerance?, will they get the reference information you want?) to your invoicing process (what can you bill for?, when can you bill it?, where do you send the bill? and what approval is needed for your customer to pay the bill?) and finally to your collections process (do you have the right AP contacts for your customer?, are you making timely follow up inquiries?, and do you have any leverage if payment issues arise?)

Having clear expectations with your customer and your employees helps to set the tone and build relationships for your company to succeed.

Creating a sound credit policy is critical to avoiding confusion with customers and keeping your company’s financial house in order. For additional resources/samples of effective credit policies, see Inc’s Finance Guide: How to Create a Smart Credit Policy

So your customer needs a rush order?

There are a variety of red flags that can signal a potential problem with payment and/or collections from your customer. Beware: repeated rush order requests is one of those red flags. A sudden need for a “rush order” from your client might signal cash flow issues on their end. This might indicate that your customer has not planned accordingly for work flow. It could also mean they are short on cash and need to expedite delivery of a good or service, to speed up their payment and resolve a cash bind. If an unexpected “rush order” request is made, don’t be afraid to ask questions of your customer, including why the rush order is needed. You may also want to ask “What happened during the production cycle to cause this sudden need?” “Do you anticipate additional rush orders in the future and why?” The answers to these questions may signal there are troubles ahead. Keep in mind a one-time request doesn’t necessarily indicate a problem, but if you receive repeated requests from the same customer, you might want to think twice.

Keys to Managing Your Collections Process

In today’s economy it is more important than ever to focus on collections.  When sales are slow, companies tend to focus on increasing business and securing new contracts, however it is important to stay just as focused on managing collections.

The popular expression “Cash is King” rings true.  Sales don’t pay bills, cash does.  While increasing sales is a critical part of building a successful business, if you aren’t being paid for your product or service, you are causing your business more harm than good.

There are some steps small business owners can take to manage the collections process and positively impact the bottom line. 

Before you make a sale or enter into a contract, you should understand the value of your product and the competition.  It is important to know your customer and your “customer’s customer.” It is important to be aware of end-users ability to pay your invoice. Can they honor the terms of the PO and will you only be paid after your customer gets paid?  For example, if you are selling your product through a distributor to a large retailer, you will likely be paid once the distributor gets paid.  When evaluating the risk, it is the distributor not the retailer who is responsible to pay the invoice, so you will need to look at the strength of the distributor.  Balancing sales with collection is looking at risk versus the reward. As a business owner, you should ask yourself “how much am I willing to lose?” and “how many ‘good’ sales do I need to make up for the ‘bad’ sale?”

The internal collections process is often overlooked, but it is crucial that you establish a clear collections procedure for your business and stick to it.  Be sure you know what you can bill for, when you can bill for it and where to send the invoice.  Send your invoices in a timely fashion and make sure to get customer approvals or “signoffs” on your work.  It is also important to make sure you have a purchase order before you start work.  Too many invoices don’t get paid because there was no formal purchase order issued.
 
As with any other aspect of your business, communication is imperative.  You should follow up with your customer’s Accounts Payable (A/P) department early.  It is much better to be aware of an issue early rather than after the payment is not received as expected.  Building a trusting relationship with your customer will keep the lines of communication open and increase the speed and reliability of repayment.  Internal communication with your sales department can also be helpful, as they may be able to collect an invoice as they are making another sale.

Unfortunately, despite efficient processes and consistent communication, issues can arise.  Note red flags along the way and respond accordingly. Some key indicators include slow payments,  rush orders, change in payment form and excuses are signs that you may have a problem. When this happens, know your leverage points.  If you can not  negotiate a payment plan, be prepared to scale back work or human resources and file liens where appropriate. You can also consider legal action or collection agencies but weigh the costs against the benefits.

While you will likely not collect 100% of your invoices 100% of the time in your business, however, following these tips may make it easier to secure your firm’s most precious resource cash.

If you are interested in learning more about this topic, Mike Semanco and Candace Pavliscak will present “Improving Collections” on July 21, 8:30 - 10:30 a.m., at Walsh College, Troy Campus. Learn more