Credit management policy –
Credit management policies are rules and guidelines established by top management that govern the company’s credit department and its performance in the extension of credit privileges. Credit procedures are employed to achieve the goals of credit management policies. Significance Credit management policies allow the credit department to operate more efficiently. Ambiguity is reduced over how to proceed when policies are clearly defined. Credit management policies can offer specific rules in regard to the loan amounts, type of customers, debt-to-income ratios, collateral requirements, payment terms, and interest rates.
There are several types of credit management policies. They are based on the industry, lending activities, and top management’s business style or approach to lending. Automotive, academic, home, retail, wholesale and credit card lending all may have different credit management policies. A tight credit management policy refers to conservative and restrictive guidelines for the extension of credit. A loose policy allows for more flexibility and may focus more on simply making sure debt is repaid instead of credit analysis and review.
Credit procedures are the specific ways in which top management requires the credit department to achieve credit management policies. They can include instructions, on what data is to be used for the credit investigation and analysis process and other procedures. Credit procedures can also provide information for the credit approval process, account suspension and instances requiring management notification.
- Cash Flow
A major influence on credit management policies is cash flow. Cash flow requirements describe the amount of money a business needs to meet its financial obligations or pay its bills. A loose credit policy in which little customer credit investigation is performed can lead to higher default rates and slower repayment of debt. This can have a significant impact on a company’s cash flow. Companies with small cash reserves or other sources of capital may be inclined to adopt tighter credit management policies.
Part of a good credit management policy should stress communication with other departments. Communication with the sales department can reduce conflict that sometimes occurs when a sale is declined or affected because the credit department determines there is the high level of risk involved in doing business with a particular customer. Communication with the collections department can provide warning signs of loan or credit default.