Limiting your customers’ payment options can mean fewer sales for your business. In addition to accepting cash, checks, and credit cards, you may consider offering credit to customers. If you want to extend credit, create a credit policy for small business.
Before you develop a business credit policy
Are you thinking about offering credit to your small business customers? Consider the pros and cons of extending business credit.
With business credit, customers purchase products or services and receive a bill later on. Because customers don’t have to pay at the point of sale, they may spend more. Also, extending credit can keep you competitive and enlarge your customer base.
Although credit can encourage spending, it can cost your business. Your customers might not pay, leaving you with slow cash flow and bad debts.
You can maximize the pros and limit the cons by tailoring your credit policy to your small business.
Creating your credit policy for small business
The credit policy of a company defines a business’s terms and conditions for extending credit and collecting payment. Customers should review your credit policy before obtaining credit.
Business credit policies differ, but most include similar sections. Use the following six steps to create an efficient credit policy for small business.
1. Determine who you will extend credit to
You could set your business up for failure if you decide to offer credit to everyone.
Some consumers have histories of not paying their debts. Performing a credit check can show you which customers generally pay their debts.
Obtain the customer’s credit report to view bill payment history, current debt, and other relevant information. You can contact the three credit reporting agencies—Experian, TransUnion, and Equifax—to view a customer’s credit report.
Keep in mind that the Fair Credit Reporting Act requires you to get permission before checking someone’s credit. Require customers to fill out a credit application before trying to obtain their credit reports.
2. Define your credit limit
How much credit can you afford to give customers on credit? Because extending credit is risky, think about what your business can handle.
For one business, a $5,000 limit is reasonable. On the other hand, another company might set a limit of $10,000.
Before determining your credit limit, calculate your business’s average liabilities. If a customer borrowed up to the limit and didn’t pay on time, could you still pay your business liabilities? What if more than one customer didn’t pay on time?
The credit limit you set might vary by customer. You can look at the customer’s annual income, debts, and credit history when determining a limit. List your credit limit terms in your credit policy.
3. Come up with credit terms
Your credit policy for small business should clearly outline your credit terms. Define how long customers have to pay, interest rates, whether you require deposits, and information about early and late payments.
Many businesses use a standard period like 30 or 60 days after purchase before requiring the customer’s first payment. Include information about payment plan structures and due dates.
When will you begin charging interest? You might extend credit to a customer interest-free for a number of days. Also, list your business’s interest rate and whether you compound interest.
Some businesses require customers to put money down when purchasing on credit. Include whether customers must make deposits at the point of sale in your policy.
Specify whether you offer early payment discounts or charge a late payment fee. Early payment discounts and late payment fees can encourage timely customer payments. Include the time frames for both early and late payments.
4. Craft an invoice template
When you work on your business credit policy, you should also think about your invoice process. Extending credit and invoicing a customer go hand in hand. So, what is an invoice?
An invoice is a bill that requests payment. After a customer makes a purchase on credit, send them an invoice. Invoices include information about the purchase, the invoice date, the payment due date, and how to pay.
5. Decide how you will pursue unpaid debts
Most likely, some of your customers won’t pay you back. Include how you will pursue unpaid debts in your business credit policy.
When a customer won’t pay, you may decide to send increasingly urgent payment reminders. If the customer still doesn’t pay, consider contacting a debt collection agency. If the customer has multiple outstanding debts, you may choose to terminate their account.
6. Consult a small business lawyer
Before you implement your credit policy for small business, consider talking with a lawyer. Your small business lawyer can read over the terms and conditions in your policy.
A lawyer can verify that you follow the Fair Credit Reporting Act. And, they (or an accountant) may offer suggestions about credit limits and terms that your business can handle.
Thinking about extending credit to customers? Make sure you stay on top of your recordkeeping responsibilities. Patriot’s online accounting software lets you track unpaid receivables, create invoices, and more. Get your free trial now!
This is not intended as legal advice; for more information, please click here.