Credit Control | Credit Policy | Credit Control Policy
Credit Control which is also referred to as Credit Policy; is a business strategy adopted by companies to encourage the sale of goods or services by providing better payment terms and extending credit to customers. Simultaneously, companies set up well defined guidelines for the terms and conditions of extending credit, and course of action in terms of late payments, to safeguard their own interests.
What are the advantages of extending credit? What are the important points to focus on while extending credit? To whom should companies extend credit? What measures will ensure good credit control? How to implement credit control with ERP software? We will cover all these aspects in this article.
Advantages of extending Credit
Businesses use innovative ways to extend credit to customers. It could either be in the form of providing credit up to a certain amount of purchases, or allocating extra time/number of days for making full payments or making staggered payments in the form of EMIs or offering certain amount of credit against each purchase and so on.
Extending credit is a great way to increase the sales and/or achieve big ticket sales. When businesses offer favorable payment terms customers are likely to make larger and more frequent purchases as they customers can plan their payments and balance their cash flow effectively.
On one hand businesses that offer better payment terms to existing customers, encourage repeat business and long term relations. While on the other hand, extending credit can prove a competitive edge for attracting new/ potential customers.
What are the precautions to be taken while extending credit to customers?
Before extending credit to customers, it is imperative to check their credit history. Companies should provide credit facility only to customers who have a track record of making timely payments . This is extremely important to ensure a healthy cash flow for their own business.
If a company extends credit a customer, who does not have the capacity to make payments on time, that business will end up with cash flow problems and may even have to write it off as bad debts, if the customers default payments.
Important Aspects of Implementing Credit Control Policy
Defining a good credit control policy is essential for providing best benefits to both parties the company and customers, at the same time, safeguarding their respective interests. It involves determining credit worthiness of customers, defining limits for amount of credit and period of credit. Clearly describing the terms and conditions of payments or collection policy and outlining the course of action in case of delays or defaults in payments. This will help avoid causes of friction and help maintain good relations among the business and customers.
Focus Areas of Credit Control Policy
- Determining Credit Worthiness/Eligibility : Identify the major points to be taken into consideration while extending credit to the respective customer. Determine whether customer has capacity to make timely payments or not.
- Maximum Amount of Credit : Clearly define the maximum amount of credit that can be extended for every customer or group of customers; depending on various factors such as their respective credit worthiness, relations with business and more. Define the threshold for raising an alert/notification informing the customer they are reaching the upper limit of credit.
- Maximum No of Days / Credit Period : Describe the maximum number of days of credit that can be provided to each customer. Outline the date when customer will receive a reminder/ notifications stating that credit period is likely to be over soon.
- Max. No. of Invoices Credit : Some companies prefer to define credit amount along with a ceiling on upper limit of number of credit invoices. For e.g. a company may decide to extend a maximum credit of Rs. 5 Lakhs for up to 7 number of invoices, whichever is earlier. Suppose a customer has outstanding payments of 7 invoices worth Rs.4 Lakhs, the customer has to clear the outstanding credit, before they can avail any further credit.
- Terms & Conditions of Payment / Collection Policy : This is one of the most important aspects that should be explicitly and clearly described. Setting up transparent terms and conditions for collections / payments from the very beginning helps both parties to be on the same page. It helps avoid any chances of delays in payments and any differences of opinions and resultant conflict.
Why Implement Credit Control?
- Ensure Timely Receipts & Healthy Cash Flow : Cash flow is the lifeline of any business. Late payments are one of the main reasons for cash flow difficulties in any business. A robust credit control system helps to establish Financial Discipline and ensures that companies receive payments on time and the company has sufficient funds to manage day to day operations smoothly.
- Save Debt Collection Time & Efforts : Debt collection can be a time-consuming affair. Staff may have to spend hours chasing customers for payments. If debt collection process is not conducted properly, the relationships with customers can turn sour and end up in legal battles that may cost a lot money and time. Some debts may eventually have to be written off reducing the profitability of the company. All these hassles can be avoided by having the right credit control policy in place.
- Healthy Relations with Customers : Providing attractive offers and payment terms to customers offers ease of doing business, improves prospects of repeat business and customer referrals. This helps establish long term relationships with customers.
How to Implement Credit Control with ERP?
An ERP software facilitates setting up the following measures to implement credit control in a company.
- Defining Limits : Companies can define Credit amount for individual/group of customers, maximum period of credit and/or maximum number of invoices. All this information can be saved in the customer master of ERP. Moreover credit information can also be mentioned on the sales invoices/tax invoices generated.
- Dunning Process: With ERP software companies can automate the process of tracking payment due dates, credit limits of respective customers. ERP software sends reminders and notifications to customers for payments due from them. This ensures faster processing of the amounts receivable from customers. Helps reduce the risk of bad debts.
- Reporting & Analysis : ERP provides different reports for identifying trends of delayed payments or amounts outstanding from customers. Companies can assess the effectiveness of the credit policy and take corrective measures such as redefining credit limits for customers not making timely payment.
- Stop Transactions : Since credit value & maximum credit days are already defined for each customer, ERP generates warning messages for the company to restrict further transactions when either credit limit or credit period or the number of transactions limits are about to be reached for respective customers.
Credit control is like a double edge sword. Hence, companies needs to be extremely vigilant while setting up the credit control processes. It is important to define, implement, monitor the effectiveness of the credit control and take corrective measures based on information gathered. ERP Software play a strategic role in implementing company-wide credit control policy