Creating an Effective Credit Policy © Presented by: Jim Menard, C.C.E. email: sugarpine@charter.net October 5, 2006 Western Regional Credit Conference Las Vegas NV

Learning Objectives Defining a credit policy The steps used in establishing a policy How a policy is implemented The types of policies The components of a credit manual

Defining a credit policy

The steps used in establishing a policy

How a policy is implemented

The types of policies

The components of a credit manual

Defining a Credit Policy Importance of Credit Policy Objectives of a Credit Department Policy & Procedures Policy & Practice

Importance of Credit Policy

Objectives of a Credit Department

Policy & Procedures

Policy & Practice

Importance A policy is a general course of action developed for recurring situations and designed to achieve established objectives. A credit procedure describes the actual working steps that should be followed A credit rule is a statement that defines the actions in a specific situation / decision

A policy is a general course of action developed for recurring situations and designed to achieve established objectives.

A credit procedure describes the actual working steps that should be followed

A credit rule is a statement that defines the actions in a specific situation / decision

Objectives The Credit policy should address the authority to do the job, establish consistent credit guidelines & incorporate credit & sales cooperation Goals should include: terms of sale, monitoring risk, sales relationships, training and department measurements

The Credit policy should address the authority to do the job, establish consistent credit guidelines & incorporate credit & sales cooperation

Goals should include: terms of sale, monitoring risk, sales relationships, training and department measurements

Scope P urpose - Plan - Performance O rganizational Expectations L evel of Understanding, Authority I nvestment, Impact and Responsibility C orporate Goals I ntentions, Instructions & Implementation E stablish Ground Rules S tability, Sensitivity, Support, Standardization

P urpose - Plan - Performance

O rganizational Expectations

L evel of Understanding, Authority

I nvestment, Impact and Responsibility

C orporate Goals

I ntentions, Instructions & Implementation

E stablish Ground Rules

S tability, Sensitivity, Support, Standardization

Policy & Procedures Credit policy serves as a guide in determining how to handle a variety of situations. It suggests several solutions within which the credit professional is free to exercise judgement

Credit policy serves as a guide in determining how to handle a variety of situations.

It suggests several solutions within which the credit professional is free to exercise judgement

Policy and Practice Changes in practice within a given policy provide flexibility in meeting changing conditions. Exceptions: do arise - be open to elevate these opportunities to senior management

Changes in practice within a given policy provide flexibility in meeting changing conditions.

Exceptions: do arise - be open to elevate these opportunities to senior management

Establishing a Credit Policy General Considerations Policy Focal Points Other Influences Formulating the Policy Reasons for a Written Policy Checklist Example

General Considerations

Policy Focal Points

Other Influences

Formulating the Policy

Reasons for a Written Policy

Checklist

Example

General Considerations A credit policy is designed to provide consistency across departmental functions. An effective credit policy permits and encourages the fullest development of the opportunities in administering credit Define: mission - vision, goals, roles, criteria, procedures and terms of sale.

A credit policy is designed to provide consistency across departmental functions.

An effective credit policy permits and encourages the fullest development of the opportunities in administering credit

Define: mission - vision, goals, roles, criteria, procedures and terms of sale.

Focal Points New Customers Terms of Sale Credit Investigations Collections Bad debts Organization Reporting

New Customers

Terms of Sale

Credit Investigations

Collections

Bad debts

Organization

Reporting

Other Influences Standing of a Company Role of Credit in the Firm Different classes of customer Length of Terms Type of Merchandise / Margins Geographical distribution Economic / Political Conditions

Standing of a Company

Role of Credit in the Firm

Different classes of customer

Length of Terms

Type of Merchandise / Margins

Geographical distribution

Economic / Political Conditions

Formulating the Policy The actual formulation of credit policy begins with the establishment of objectives. What does the company want to accomplish ? Set standards Either written or implied

The actual formulation of credit policy begins with the establishment of objectives.

What does the company want to accomplish ? Set standards

Either written or implied

Reasons for a Written Policy A written policy is more useful because it can be source of stability and continuity in the operation, not only of the credit department but also of the company as a whole...

A written policy is more useful because it can be source of stability and continuity in the operation, not only of the credit department but also of the company as a whole...

Checklist Formal organization Job descriptions Budgets Documentation requirements Credit gathering information Time limits on duties New account guidelines

Formal organization

Job descriptions

Budgets

Documentation requirements

Credit gathering information

Time limits on duties

New account guidelines

Guidelines - #2 Communication guidelines Marginal account guidelines Slow Pay accounts - Reducing Bad Debts Unauthorized deductions / disputes Terms of Sale - Secured Transactions Guidelines for management reporting

Communication guidelines

Marginal account guidelines

Slow Pay accounts - Reducing Bad Debts

Unauthorized deductions / disputes

Terms of Sale - Secured Transactions

Guidelines for management reporting

The credit department shall function under the supervision of the treasurer, and its activities shall be coordinated with overall corporation policy and the activities of the sales department. It shall be the responsibility of the credit department to help build a broad and durable customer relationship for [company name] Corporation. In the performance of this duty, the credit department shall maintain a positive and constructive attitude toward [company name] Corporation's customers. Discrimination in customer relationships is to be avoided. Likewise, the credit and sales departments shall maintain a cooperative attitude, with an aim toward promoting sales. Within the bounds of sound credit practices, the credit department shall endeavor to find a suitable credit basis on which to deal with every customer that the sales department desires to have purchase our products. The decision as to what constitutes a suitable credit basis shall rest with the credit department. From the standpoint of credit, no customer shall be denied the right to purchase our products until every means of selling to that customer has been exhausted. Standards by which credit risks are accepted or rejected shall be flexible enough to permit the maximum of profitable sales by [company name] Corporation. Marginal credit risks are to be dealt with when they are needed to complete operating schedules, and as long as they constitute a source of added net profit to [company name] Corporation. Customer contacts are to be kept on a dignified and friendly basis, conducted so as to promote a wholesome respect for [company name] Corporation and its business practices. Credit department practices shall be designed to permit the maximum number of orders to flow without interruption through the sales department, but to provide for interception when necessary as a means of safeguarding credit extensions. The credit department shall keep the sales department fully informed regarding the status of a customer's account when the free flow of orders from that customer is in jeopardy. The credit department has the collection responsibility. Sales department advice or direct help may be sought in exceptional cases. All credit decisions shall be independently made and shall conform to requirements of law. Example of a Credit Policy

Implementing a Credit Policy General Considerations Communication of the Policy Assignment of Responsibility Establishing Procedures Applying the Policy Influencing Factors Change in Conditions

General Considerations

Communication of the Policy

Assignment of Responsibility

Establishing Procedures

Applying the Policy

Influencing Factors

Change in Conditions

General Considerations To be effective, a policy must be directly and explicitly related to action Translate broad, flexible policy statements into guides for the daily operation of the department The creation of an atmosphere that encourages your staff to be aware of their decisions and how it affects the company

To be effective, a policy must be directly and explicitly related to action

Translate broad, flexible policy statements into guides for the daily operation of the department

The creation of an atmosphere that encourages your staff to be aware of their decisions and how it affects the company

Communication of Policy A basic requirement is the effective communication of the policy both inside and outside of the credit department Top management should not only encourage the policy but also support it to others within the company Excellent Sales Training tool

A basic requirement is the effective communication of the policy both inside and outside of the credit department

Top management should not only encourage the policy but also support it to others within the company

Excellent Sales Training tool

Assignment of Responsibility Credit policy establishes the broad limits for decisions over a long period of time. The definition of authority should make clear the channels through which an order must move until it is finally approved Exceptions to the policy should require the approval of a senior member of the staff

Credit policy establishes the broad limits for decisions over a long period of time.

The definition of authority should make clear the channels through which an order must move until it is finally approved

Exceptions to the policy should require the approval of a senior member of the staff

Establishing Procedures Procedures translate policy into clear cut rules for specific situations New Accounts Updating current accounts Credit terms Assigning risk categories Customer visits Credit References

Procedures translate policy into clear cut rules for specific situations

New Accounts

Updating current accounts

Credit terms

Assigning risk categories

Customer visits

Credit References

Establishing Procedures #2 Collateral Collection of accounts Collection Agency Bad Debts Computer systems / software Activity reports Evaluating department personnel

Collateral

Collection of accounts

Collection Agency

Bad Debts

Computer systems / software

Activity reports

Evaluating department personnel

Applying the Policy The policy is intended to apply to the great majority of the company’s credit activities over a long period of time. It may be necessary to shift the emphasis in different situations (e.g. geographical, business conditions, economy, trends and national customs).

The policy is intended to apply to the great majority of the company’s credit activities over a long period of time.

It may be necessary to shift the emphasis in different situations (e.g. geographical, business conditions, economy, trends and national customs).

Influencing Factors Flexibility Consistency Fairness Current financial condition Business conditions General economy

Flexibility

Consistency

Fairness

Current financial condition

Business conditions

General economy

Changing Conditions Critical factors profit margins cash flow A/R aging Bad Debts Competition Market share

Critical factors

profit margins

cash flow

A/R aging

Bad Debts

Competition

Market share

Review of Credit Policy Review on a regular basis Conduct internal audits Discuss proposed changes Critical examination of current policies and procedures Stay up to date

Review on a regular basis

Conduct internal audits

Discuss proposed changes

Critical examination of current policies and procedures

Stay up to date

Types of Credit Policy Analysis of Risk - how much risk is the firm willing to take in granting credit ? Risk Criteria - will you be paid ? Stay within credit limits ? Creditworthiness Financial stability Pay within terms

Analysis of Risk - how much risk is the firm willing to take in granting credit ?

Risk Criteria - will you be paid ?

Stay within credit limits ?

Creditworthiness

Financial stability

Pay within terms

Types... Degree of collection effort How much effort are you willing to spend in collecting account ? How will you treat past due customers ? Will unearned discounts be allowed ? How will you handle deductions ?

Degree of collection effort

How much effort are you willing to spend in collecting account ?

How will you treat past due customers ?

Will unearned discounts be allowed ?

How will you handle deductions ?

Credit Procedures Manual Importance - ready reference Rules, regulations, procedures & operations Format - book form Kept current, flexible & logical Short form to train new sales staff

Importance - ready reference

Rules, regulations, procedures & operations

Format - book form

Kept current, flexible & logical

Short form to train new sales staff

Contents Table of contents Exhibits - samples Security devices Credit approval administration Collections Reports Credit application - forms

Table of contents

Exhibits - samples

Security devices

Credit approval administration

Collections

Reports

Credit application - forms

Question time……….. Time to ask your questions…

Time to ask your questions…