Credit and accounts receivable management

Even a very small business can decide to provide credit to its customers. Many small and medium-sized enterprises (SMEs) lend to customers to do business. About one-sixth of all US industrial company assets are accounts receivable, so lending is a significant investment in the US today. Lending is actually an investment in your customers. First you need to decide which customers are worth this investment.

Not all small businesses provide credit. Instead, they make all of their sales on a cash basis. In many cases, this costs them sales and customers because, like it or not, we live in a credit-driven society. If a supplier needs to place a larger order from a company, that supplier may not have the funds to pay for everything upfront. This order goes to another business unless your small business provides credit. Small businesses face a trade-off; they must weigh the cost of lending against the benefits of increasing sales.

Most small businesses have two types of customers. You have B2B customers or trade credit customers. Trade credit is simply lending to other firms. Small businesses also have B2C customers or consumer credit customers, meaning the public.

What does credit policy mean for a company?

When a business performs a cost-benefit analysis and makes the very important decision to extend credit to its customers, it needs to establish credit and collection procedures. A good credit policy usually consists of three parts:

• Terms of Sale: The terms of sale for a credit customer specify how the company will sell its products or services. Will the company require a cash sale or provide credit? This decision is made through the process of credit analysis and determines who should be given credit. If the small business decides to extend a loan to a customer, it must set conditions. These terms include the credit period and any discounts you offer the customer along with the discount period. Terms of sale can look like this: 2/10, net 30. This means that you give your customers a 2 percent discount if they pay within 10 days. If you do not claim the discount, your invoice is due within 30 days.

• Credit Analysis: In determining credit policy, a company determines how it will provide credit to consumers and businesses. To do this, they use a number of methods, including pulling credit reports, assessing the 5Cs of creditworthiness, and credit scoring.

• Collections Policy: If a business decides to offer credit to its customers, it must develop a collections policy that it uses to monitor its credit accounts. Most companies use two approaches. You use the average collection period and aging schedule from Accounts Receivable. Average Collection Period (ACP) tells a business owner how many days, on average, it takes to collect credit accounts. The business owner can compare the ACP to other companies in their industry and to the ACP from other years. The ACP provides the business owner with a wealth of data to work with. If the ACP increases, the business owner should take more aggressive collection actions on their credit accounts. The receivables aging schedule is also a valuable tool. You can see at a glance what percentage of your credit accounts are late and how many are overdue until considered uncollectible. Between the aging plan and the ACP, it’s relatively easier for a business owner to keep track of credit accounts and fix any problems that could be affecting the company’s cash flow before they arise.

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