Credit policy sample

A sample credit policy contains a number of elements that are designed to reduce the risk of loss
from extending credit to customers that cannot pay. The key parts of a credit policy are:
Purpose: This section of the policy briefly states why the policy exists.
For example: This policy outlines the requirements for establishing payment terms with the
company's customers, as well as the monitoring of those terms.
Scope: This section identifies the types of sales to which the policy applies. It may only apply to
sales within a certain country or region, or to certain types of contracts or sales.
For example: This policy applies to all sales made within the United States, excluding sales to the
federal government and state governments.
Policy: The main body of the policy can include a number of statements regarding credit policy,
along with more detailed application information.
For example: The company will extend credit to customers if they meet its limit criteria for the
granting of credit. The basic form of credit is a maximum credit of $10,000, with no security
interest. In situations where a customer's ability to repay is in question, a personal, corporate, or
bank guarantee may be required. The credit department will review the credit applications of all
new customers to determine their worthiness to receive credit, and the amount of that credit. The
credit department will periodically review the repayment history of existing customers to
determine whether their existing credit levels are reasonable, or need to be revised.
Responsibility: The policy should state who has responsibility for the extension or revision of
credit.
For example: The credit manager is authorized to extend credit to customers, and to communicate
with them regarding their credit status. The credit staff is also responsible for instructing
customers regarding their payment responsibilities.

Accounts receivable analysis

Accounts receivable are the amounts owed to a business by its customers, and are comprised of a
potentially large number of invoiced amounts. Accounts receivable represent the primary source of
incoming cash flow for most businesses, so these invoices should be analyzed in order to establish
the health of the underlying cash flows.
Accounts receivable analysis techniques:
One of the easiest methods for analyzing the state of a company's accounts receivable is to print
an accounts receivable aging report, which is a standard report in any accounting software
package. This report divides the age of the accounts receivable into various buckets, which can be
 sometimes changed within the accounting software to match the billing terms. The most common
time buckets are from 0-30 days old, 31-60 days old, 61-90 days old, and older than 90 days. Any
invoices falling into the time buckets representing periods greater than 30 days are cause for an
increasing sense of alarm.

There are several issues to be aware of when you analyze based on an aging report:

 Individual credit terms. Management may have authorized unusually long credit terms to
specific customers, or perhaps only for particular invoices. If so, these items may appear to be
severely overdue for payment when they are, in fact, not yet due for payment at all.
 Distance from billing date. In many companies, the majority of all invoices are billed at the
end of the month. If you run the aging report a few days later, it will likely still show
outstanding accounts receivable from one month ago for which payment is about to arrive, as
well as the full amount of all the receivables that were just billed. In total, it appears that
receivables are in a bad state. Time
 Bucket size. You should approximately match the duration of the time buckets in the report to
the company's credit terms. For example, if credit terms are just ten days and the first time
bucket spans 30 days, nearly all invoices will appear to be current.
 Unapplied credits. There may be unapplied credits on the report. If so, clean up the report by
researching which invoices they should have been applied against. Doing so may reduce the
amount of overdue receivables listed on the report.

Another accounts receivable analysis tool is the trend line. You can plot the outstanding
accounts receivable balance at the end of each month for the past year, and use it to predict
the amount of receivables that should be outstanding in the near future. This is a particularly
valuable tool when sales are seasonal, since you can apply seasonal variability to estimates of
future sales levels. Trend analysis is also useful for comparing the percentage of bad debts to
sales over a period of time. If there is a strong recurring trend in this percentage,
management may want to take action. For example, if the percentage of bad debt is
increasing, management may want to authorize tighter credit terms to customers.

There are several issues to be aware of when you use trend line analysis:

 Change in credit policy. If management has authorized a change in the credit policy, this can
lead to sudden changes in accounts receivable or bad debt levels.
 Change in products or business lines. If a company adds to or deletes from its mix of products
or business lines, this may cause profound changes in the trend of accounts receivable.
 Change in business conditions. If the economy is in decline, there may be an increasing trend
of bad debts that is well above the historical average.

A third type of accounts receivable analysis is ratio analysis. The most commonly used ratio is
the accounts receivable collection period, which reveals the number of days that an average
customer invoice remains outstanding before it is paid. The formula is:

Average accounts receivable ÷ (Annual sales ÷ 365 Days)

For example, if there are usually $500,000 of accounts receivable outstanding at any time, and
annual sales are $3.65 million, then the accounts receivable collection period is calculated a s:

$500,000 Accounts receivable ÷ ($3,650,000 Annual sales ÷ 365 Days)

= 50 Days collection period

In the example, we cannot tell if a 50-day collection period is good or bad, since we do not
know the duration of the credit terms.

In summary, the best way to analyze accounts receivable is to use all three techniques noted
here. You can use the accounts receivable collection period to get a general idea of the ability
of a company to collect its accounts receivable, add an analysis of the aging report to
determine exactly which invoices are causing collection problems, and then add trend analysis
to see if these problems have been changing over time.