10 Chapter 9 –Trade Credit

A business should have established a credit policy. Developing and enforcing a credit policy are risk management tools that protect a business from customers that can’t meet payment deadlines on time (or ever.) Credit policies will outline the credit department’s governing principles for how trade credit is handled. As the credit policy has a direct impact on sales, it is also considered a marketing tool for the business.

Typically, a credit policy should include the following (adapted from Dun & Bradstreet, 2022):

1. What is the mission of the credit policy? The mission statement of a credit policy should align with the company’s mission statement. An example from Dun & Bradstreet, “The credit department defines the requirements for establishing trade credit for new customers and maintaining credit lines and limits for active accounts and returning customers with appropriate payment terms. The credit department also strives to offer optional payment methods to facilitate sales to customers with sub-optimal credit histories.”
2. What are the goals of the policy? This may be common sense, but one key goal should be that the company will collect on the extended credit. Another goal could be that the company will keep the percentage of past due accounts below a certain target. Overall, these goals should be in alignment with the overall business goals.
3. Who has specific credit responsibilities? Roles and responsibilities should be clearly defined. Having authority and responsibilities clearly stated will create efficiencies and reduce redundancies. For example, a policy could dictate that credit managers are solely responsible for assessments and approvals. This will help to minimize collections and will also align with corporate financial goals (e.g., a “pre-check” from sales will not expedite the order).
4. How is credit evaluated? This is where a business can establish the level of risk they are willing to take on. A policy that accepts higher risks to achieve higher sales can see larger bad debts occurring and increased costs due to financing receivables. A policy which is risk averse to minimize bad debts can see high credit department costs because of more thorough investigations and, ultimately, lower sales.
5. How are collections handled? The collections process should be documented and followed for each customer. This will ensure consistency and, ultimately, help the business achieve the goal of collecting funds owed. Consequences for customers who are not meeting the terms of their agreements should be made clear and included in the invoice that is provided to customers.
6. What are the terms of sale? Deciding on the terms of sale will depend on the products/services that a business provides. Consider the competitors’ terms of sale when establishing the terms of sale; this can have a direct impact on a business’s sales.

Click the following link to further review Dun & Bradstreet’s Sample Credit Policy.

Once a credit policy has been established, a business should ensure that proper training and documentation of procedures exist to reduce any confusion among employees. Having a process in place allows for periodic review and helps determine how successful the policy is.

Much like a credit application in a consumer credit situation, trade credit requires the collection of information. This is so the credit manager can be better informed when they are granting or extending credit. The following information is needed in a basic trade credit application.

Contact Information. This will include the company’s name, names of the business owners, and the address for billing and shipping. This should also include the accounts payables/receivables contact information.

Bank References. Bank references are easier to obtain if the customer uploads their bank’s information along with their credit application. If they do not provide this upload, the credit manager will need to get a signed agreement from the customer to send to the bank to release this information. Customers may hesitate to provide this information due to privacy concerns. A business should incorporate proper security for the collection of sensitive information.

Trade References. Trade references can be difficult to obtain but do help with determining the customer’s repayment history with other businesses. In some instances, the customer can provide their utility or credit card bills. Some businesses may use a credit report.

Financial Information. A customer should provide their financials so the creditor manager can do a quick review of the financial viability of the customer’s business. Depending on the policies of the business granting the trade credit, unaudited financials may be acceptable.

Terms and Conditions. Terms and conditions should include the penalties and late fees that can be applied for non-payment. It is advisable to have a lawyer review this section to ensure the application/agreement can be enforced.