A credit policy is the blueprint used by a business in making its decision to extend credit to a customer. The primary goal of a credit policy is to avoid extending credit to customers who are unable to pay their accounts. The credit policy for some larger businesses can be quite formal, involving things such as: specific documented guidelines, customer credit applications, and credit checks. The credit policy for most small businesses tends to be quite informal and lacks the items found in the formal credit policy of a larger business. Many small business owners rely on their instincts as their credit policy.
Your credit policy has a direct effect on the cash flow of your business. A credit policy that is too strict will turn away potential customers, slow sales, and eventually lead to a decrease in the amount of cash inflows to your business. On the other hand, a credit policy that is too liberal will attract slow paying (even nonpaying) customers, increase your business's average collection period for accounts receivable, and eventually lead to cash inflow problems. A good credit policy should help you attract and retain good customers, without having a negative impact on your cash flow.
See our discussion of building
a credit policy that works for more information about setting up and
maintaining the credit policies for your business.