Many small businesses make the mistake of putting
off developing credit and collections policies until they have a problem with
an overdue account or available cash. The first step in developing a credit
policy is deciding whether you should extend credit at all.
Before developing a policy, examine your business
goals then ask yourself these questions:
• Why do I
want to extend credit? Business owners tend to view making sales as
paramount, but if extended credit ties up large chunks of your cash then it is
bound to cause you serious problems down the road.
• What do I
want to achieve by extending credit? This should be answered in terms of
expected incremental sales, incremental profits and/or incremental customers.
In other words, you should be able to say for example: If I extend credit to
20% of my customers, my sales should increase by $100,000 and my profit should
go up by $10,000 and/or I should be able to get 10 new customers.
costs are associated with the policy in terms of cash tied up? Would the
interest expense on that cash be offset by the net gains (i.e. profit)?
• Is my
business such that I even need to extend credit? Research what is normal
for your industry. This can be your yardstick.
• Can I afford to offer credit? The answer
to this will depend on your cash flow. Remember, credit is the same as having
your business extend an unsecured loan to its customers. Avoid borrowing from
the bank and paying interest to support cash flow shortages caused by slow
Some factors to consider:
• The better
you know your customers, the more likely you are to offer them credit.
• The bigger
your customers, the greater the potential for them to dictate a Credit Policy
that ties up large chunks of your cash, or significantly hurts your business if
the customer fails to pay.
• The larger
the size of the transaction, the more likely it is that you will need to offer
• The more economically depressed the business
neighbourhood is, the less likely that you will extend credit.
Think of a Credit Policy as your way of making
your customers pay you when you want them to. Again, how you set it up should
depend on your cash flow as well as what’s normal for your industry and your
own business objectives.
This is an excerpt from “Financial
Management: A Workbook for Small Business” published by Women’s Enterprise
Centre (WEC) and available for download at wec.ca/LearningGuides.