The Relationship Between Customer Credit Policies and Business Profitability

1. The Relationship Between Customer Credit Policies and Business Profitability • Hey there, business owner! Is providing credit to your customers while keeping your profit margin the balancing act you are facing? You're not alone. Credit for business owners can be like walking a tightrope: you want to extend credit (in the form of accounts receivable) to grow sales but also avoid unpaid invoices that damage your bottom line. • In this guide, we’ll look deeper into how your customer credit policy will affect your business profitability. You'll discover credit scoring models, negotiating better payment terms, and how to mitigate risks to make better decisions. By the time you’re done, you’ll feel confident about developing credit policies to maximize sales but with a minimum of financial risk. • Do You Know the Profitability to Credit Relationship • It is a good way to increase sales volumes, but it also carries some risk: giving credit to customers. The trick is seeing which customers will yield profitable business and which ones might lose you money by defaulting. • How Profitability is Directly Impacted by Credit Policies • Credit policies determine: • Which customers you work with • How much credit you extend • Your cash flow patterns • Your bad debt expenses Your capacity for investingin growthopportunities •

2. TheMain Elements ofEffectiveCreditPolicies • CreditApplicationProcess • A well-designed creditapplicationcapturesthe informationyouneed: • Businessbackground • Financialhistory • Ownershipstructure • Trade references • Bankingrelationships • CreditLimits • Determiningappropriatecredit limits includes: • Data uptoOctober2023 • Industry standards • Workingwithinyour risk tolerance • Periodic reviewandadjustment of limits • PaymentTerms • Payment terms shouldbeclear; specify: • Invoiceduedates • Discount periods • Late payment penalties • Consequencesof non-payment • Credit ScoringSystems andRiskAssessment • Toassesstheriskof customers, acredit scoringsystemis implemented. • InternalCreditScoring • Developcriteria basedon: • Financialstatements analysis • Businessreputation • Historyof payments toyour company • Industry risk factors • ExternalCreditReports • Use credit reportingagenciesto: Verifyfinancialinformation •

3. Identify red flags • Get impartial risk assessments • Track bankruptcy filings • Setting Appropriate Payment Terms • While terms favor customers, you also have cash flow requirements which need balancing. • Net 30 vs. Net 60 • Shorter durations help cash flow but could decrease sales volumes. • Dynamic Discounting • Consider providing early payment discounts to facilitate cash flow while still sustaining profitability. • Milestone Billing • On large projects, bill at key completion milestones to mitigate risk. • Managing Defaulted Accounts and Writing Off Invoices • Even with good credit policies, some customers will default on payments. Hence, you should be aware of how to write off invoices in QuickBooks. • Collection Process • Get it organized: • Send polite reminders • Escalate to formal demands • Involve collection agencies • Take legal action if necessary • Bad Debt Accounting • Make appropriate entries for bad debts to keep the books balanced. • Policies on Credit: A Balancing Act Between Risk and Reward • Regular Policy Reviews • Review credit policies at least once a year, or whenever market conditions change. • Customer Segmentation • Depending on risk and profitability, treat different customer segments differently. • Technology Integration • Credit management software: Automate the monitoring and alerts.

4. Frequently Asked Questions About Customer Credit Policies Q: What are the best ways to assign reasonable credit limits to new customers? A: Set conservative limits based on the information from their credit application and then adjust based on their payment history with your company. Q: Is it beneficial to offer short-term payment terms like Net 15 or Net 30? A: Generally, short-term payment terms can result in better cash flow, but you may have to weigh this against what is customary for customer wishes in your sector. Q: How frequently should I review customer creditworthiness? A: Annual reviews are typical, but high-risk customers or during economic volatility may warrant more frequent assessments.