How to create a watertight credit policy

As a business owner, it is important that if you are going to offer credit to customers, you have a credit policy in place to mitigate some of the risk.

Your credit policy should be clear and protect both your business from non-payment and your clients from getting themselves into undue debt.

Here are six tips to keep in mind when drawing up your credit policy:

Know your risk tolerance

Before you start allowing clients to use your services on credit, look at your financial standing and cashflow to work out how much risk you are able to take.

Ask yourself how much in late payments can your business handle without affecting day-to-day costs? What percentage of your accounts payable can you afford to write off as bad debt?

Once you have a total, you can work out how much of this amount you will allow your customers to borrow from you.

Evaluate each customer individually

When extending credit, you have a legal responsibility, according to the National Consumer Credit Protection Act 2009, to not suggest credit that is unsuitable for the customer. To stay on the right side of the law, it is recommended you assess each customer who applies for credit thoroughly.

Within your application process it is recommended you ask for their credit record, financial statements and payment history.

Other items to be included in your application form should be:

• The client’s ABN
• Their physical address
• Their billing address
• The type of business entity (sole trader, company or trust)
• Credit references (other suppliers who have extended them credit)
• A form of personal guarantee or director’s guarantee

Once you have this information, you can assess the customer’s financial behaviour and ability to pay off debt.

It is also recommended you assess your clients within the macroeconomic environment. This means looking at current industry trends in their sector to help plan for potential changes.

You can divide your clients into groups or bands according to their risk. A low-risk client can be offered more credit and vice versa. You can also include additional terms and conditions for high-risk customers, such as penalties for overdue payments.

Have clear terms and conditions

In your credit application process, you should outline your payment terms to avoid disputes. Most importantly, lay out the timeline of when you expect payment. This is typically within seven, 14, 21 or 28 days.

Your application should also clearly state what forms of payment you accept. If you choose to exclude a method, for example you are a cash-free business, this must be made clear in writing.

Clearly lay out your policy for charging interest on late payments and any fees associated with overdue accounts. This will help avoid any misunderstandings.

Conduct regular reviews

Update your credit policy to adapt to changing regulations and market conditions. Legal aspects to look out for include the National Credit Protection Act 2009, changes to business dispute resolution regulations and any new tax implications.

Also reassess your debtors regularly to ensure their documentation is up-to-date and their account is acceptable. This gives you a chance to adjust someone’s line of credit if they have proven a loyal customer and good debtor, or to lower someone’s credit if they have been inconsistent.

Actively pursue outstanding accounts

Even a watertight credit policy won’t help unless you are diligently chasing up outstanding payments.

Before you set out your debt collection process, familiarise yourself with what is legal when chasing overdue accounts. The Australian Competition and Consumer Commission, together with the financial services regulator, ASIC, has drawn up a guide for debt collection that you can use as a benchmark.

Consult a financial expert

Consult your accountant to help establish your risk tolerance and to assess your business’s financial health before extending credit.