Most businesses appreciate that a customer’s purchasing decisions may hinge on the provision of credit. Consequently, most businesses offer some form of credit to their customers. Those that don’t, risk losing customers to competitors.


On the other hand, credit costs a business in many ways such as the cost of borrowing that money, administrative costs for collection and the lost opportunity cost of using that money elsewhere. Issues of late payments and bad debt can also arise.


These risks can be reduced by using a smart credit policy, especially during times of economic uncertainty. Some common policy terms that are worth considering are discussed briefly below.


Timing: Invoices or purchase orders often say that payment is required within 20 days of delivery of the good or service. The business carries the risk of non-payment for 20 days for no additional fee or interest. Apart from specifying a normal interest rate that applies for the 20 days, you could also specify a higher default interest rate that applies to late payments or an incentive for early payment could include waiving interest if payment is made within 20 days. A further incentive could be to reduce the invoice by a small percentage in exchange for early payment.


Remedies: If a customer fails to make payment, there is no automatic right to claim legal and collection costs from the customer. To be able to claim such costs, your credit policy should specifically say that all legal fees on a solicitor/client basis, costs of enforcement and collection will be payable by the customer if there is a default. You could also add that any waiver or indulgence given to the customer will not apply to these costs unless you specify this in writing.


Creditworthiness: In cases where you wish to check a customer’s creditworthiness, it can be useful to run a credit check with an agency or to simply call other trade creditors of that customer. A list of references could be included in your application for credit and permission to communicate with the credit agency and references should be included to avoid privacy law issues.


Escalation: A common method for identifying debtors of concern is to establish the average time in which customers make payment so that you have a baseline from which to compare customers. It can be useful to include in the credit policy a schedule as to what will happen with delinquent debtors. For example, there may be a reminder 5 days after the due date, a second reminder at 10 days and if payment is still not received then the debt will automatically be passed to a collection agency.


The preceding paragraphs briefly describe some of the considerations that go into an effective credit policy. A thoughtfully designed policy should save you time chasing debtors, collection costs, enhance customer relationships and ultimately improve your balance sheet. Your lawyer will be able to recommend a comprehensive policy tailored for your business and customers.

Aman Prasad

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