A credit policy is a set of guidelines and procedures that a company or financial institution follows when deciding whether to extend credit to a potential borrower. It outlines the criteria for granting credit, the terms and conditions under which credit will be offered, the documentation required, and the process for dealing with delinquencies or defaults.
A comprehensive credit policy might include:
- Credit Assessment Criteria: This includes the factors the company will consider when evaluating a customer’s creditworthiness, such as their credit history, financial stability, and ability to repay.
- Credit Terms: The terms under which credit will be extended, such as the credit period (how long customers have to pay), the interest rate, and any discounts for early payment or penalties for late payment.
- Credit Limits: The maximum amount of credit the company will extend to a single customer or a class of customers.
- Documentation and Approvals: The documentation required from customers to apply for credit and the internal approvals needed to grant credit.
- Collections and Delinquencies: Procedures for collecting payments and dealing with late payments or defaults, including when to involve a collections agency or take legal action.
- Review and Monitoring: Regular reviews of customers’ creditworthiness and the overall performance of the credit portfolio, including monitoring for changes in the economic environment that might affect credit risk.
A well-defined credit policy helps to balance the company’s risk of non-payment against the potential for increased sales and customer satisfaction. It also ensures consistency in credit decisions and helps to meet regulatory requirements for managing credit risk.
Example of a Credit Policy
Let’s create a hypothetical example of a credit policy for a wholesale electronics company, “TechWholesale Inc.”
- Credit Assessment Criteria: TechWholesale Inc. will evaluate a customer’s creditworthiness based on their credit history, financial statements, trade references, and business reputation. A minimum credit score of 650 is required for all new customers.
- credit terms: Standard credit terms are Net 30 days. Interest will be charged on overdue accounts at a rate of 1.5% per month.
- credit limits: Initial credit limit will be set at $5,000 for new customers. This limit may be increased after six months of on-time payments and satisfactory business relationship.
- Documentation and Approvals: Customers applying for credit must complete a credit application form, provide the most recent financial statements, and supply at least three trade references. All credit applications must be approved by the Credit Manager.
- Collections and Delinquencies: Accounts over 60 days past due will be referred to a collections agency. Customers with accounts 90 days past due or more will be placed on credit hold, meaning no further goods will be shipped on credit until the account is brought current.
- Review and Monitoring: Customer creditworthiness will be reviewed annually, or more frequently if there are concerns about a customer’s ability to pay. The company will also monitor industry and economic trends that might impact customer credit risk.
This is a simplified example. In real life, a credit policy might be more detailed and could include other elements such as dispute resolution procedures, specific roles and responsibilities of staff involved in credit management, and alignment with broader financial and business strategies.