Close the door. Let your voice mail take your calls. It's time to review your credit policy.

Your policy should be periodically reevaluated to ensure it's in keeping with the company's strategic goals. In addition, as situations change, so should your policy so you can continue to minimize risk, accept new customers and increase sales.

"A credit policy should be changed in response to changing economic situations," according to Gary W. Emery, Ph.D., Price College of Business, University of Oklahoma. "The company that quickly adapts to new situations is the company that will benefit most."

Consider the following:

• When to review your policy. A comprehensive review is needed when:
  • Long-range plans are formulated. "When you make a plan," Emery says, "you're making an assumption about whether you'll have long or short credit periods and whether you'll offer cash discounts, consequently, how many dollars of your accounts receivable you will finance. Forecasts about accounts receivable have implicit assumptions about what your credit policy will be. "When those forecasts are prepared it's a good time to examine your policies and determine whether the policy you've been following is still effective for the company."

  • Circumstances change. Be alert to any economic changes that require changes in your policy. For example, if you're extending credit to small customers because you have better access to financing, once they can obtain financing from other sources, it's time to decide whether it's worthwhile to continue offering credit to these customers. Or, if a customer is growing but still doesn't have access to financing, you may want to offer even more credit to help this customer reach its goals.

  • Interest rates change. When interest goes up, it's time to reevaluate whether the benefits of extending credit outweigh the cost.

• What to review. Aspects of your credit policy that should be reviewed include:

  • Credit terms. This should be a well-established written policy, such as net 30 or 30/10/2%, that applies to all customers.

  • Credit standards. How much financial risk the company is willing to take. Whether credit will be offered to high-risk customers or only to low risk customers.

  • Credit line. This covers the amount of credit that will be extended to individual customers and how it will be determined. Decisions may be based on the volume of business a particular customer does with the company, the amount of risk involved in extending credit to the customer, the customer's balance sheet and the reliability of the customer's cash flow.

  • Payment monitoring. To ensure that customers are paying according to terms, there should also be guidelines concerning specific actions to take when payments are slow.

    This includes when to make collection calls, send letters, resort to more aggressive letters, to suspend credit sales and when to turn an account over to a collection agency or an attorney.

    If your customer base is too large to allow monitoring each and every account, your policy should include what measurement, such as DSO, will be used to gauge overall performance.

• Room for exceptions. Allow for flexibility in making credit decisions so you can accept higher risk customers on a case-by-case basis by attaching specific conditions.

  "If managers have no opportunity to depart from policies," according to Emery, "then they aren't functioning as managers. They should have the opportunity to use their judgment to respond to situations. That's why we have exceptions to policies.

  "Exceptions are case by case approaches recognizing that no policy can ever be comprehensive enough to consider all factors that go into making a complicated decision."

• Other considerations. Additional factors pertaining to your particular business should also pay a role in how you formulate your policy. These include:"

  • Inventory costs versus greater financial risk. Selling on credit means greater financial risk but selling on a cash basis or only to customers you're sure will pay means fewer sales and higher inventory costs.

    In addition, while some products are better kept in inventory because the financial risk is too great, with other products it's best to shift the risk to receivables because storing the product is risky. Such products include foods with a short shelf life.

    "When you sell on credit," Emery says, "you swap one risk for another. You don't have to protect the product anymore. There are no shrinkage costs, no insurance and no taxes. Instead, there's the risk that the customer who bought the product won't pay. You have to finance receivables instead of financing inventory."

  • Product delivery. This also presents several risks and there are tradeoffs here as well.

    If selling on a cash basis, you eliminate the risk that customers won't pay, but besides the risk that products may be damaged, there's additional risk that delivery personnel may not be trustworthy when it comes to your money.

    If, on the other hand, you sell on credit, the only risk with delivery personnel is possible damage but there's also the risk that customers won't pay.

• Upper management involvement. Whenever a credit policy is either written or updated, top managers should provide input since the amount of credit extended to customers is usually significant.

  "It's not unusual for a company," according to Emery, "to have one-fourth or more of its assets in accounts receivable, although the company's business may be manufacturing, not finance. It's very important that senior managers, particularly financial managers, have input into the company's policies because these policies will obligate financial managers to raise funds to finance the investment in receivables."

  Other managers who should be involved include marketing and sales managers since credit policies have a significant impact on the company's ability to sell. Production managers should also be involved because selling on credit impacts inventory.

  "Managers have to determine where they have and advantage compared to customers," according to Emery. "If the product is wheat, they can store it better than their customers. If it's fish, the customer has the advantage.

  "The same applies to financing. If the supplier is a big company, it can probably borrow money less expensively than its customers so it might use credit to help customers. If the supplier is not a large company, it probably won't use credit for that purpose."

The cost and benefits of extending credit costs are only a few factors to consider when reviewing your credit policy.

Most important, your credit policy should enable your company to reach strategic goals.

Editor's Note: The above article originally appeared in the Credit & Collection Manager's Letter, a newsletter purchased by Credit Today in 2006. This article originally appeared prior to 2000.