Introduction
Every bad debt write-off traces back to a specific moment: a decision to extend credit to a customer who ultimately couldn't or wouldn't pay. A clear, consistently applied credit policy doesn't eliminate this risk entirely, but it catches most of it before the invoice is even issued — which is a genuinely better place to manage risk than during collections.
Table of Contents
- Why a Credit Policy Matters
- The Three Core Components
- The Credit Application Process
- Setting Credit Limits That Make Sense
- Standardizing Payment Terms
- The Biggest Mistake Businesses Make
- Reviewing and Adjusting Over Time
- FAQ
- Conclusion
Why a Credit Policy Matters
Extending credit is, functionally, a lending decision — a business is agreeing to deliver value now in exchange for a promise of payment later. Treated casually, this is exactly how unpaid invoices and eventual bad debt accumulate. A genuine credit policy exists to make this decision consistent and deliberate, rather than an informal judgment call made differently for every new customer.
The Three Core Components
A workable credit policy needs:
- A consistent application process for any customer requesting terms above a defined threshold
- Credit limits tied to actual creditworthiness, not a flat number applied to everyone
- Standardized payment terms, applied consistently rather than negotiated case-by-case under pressure
The Credit Application Process
For any customer requesting credit terms above a reasonable threshold, a basic application should collect:
- Business name and legal structure
- Time in business
- Trade references — other vendors the customer already has credit relationships with
- A bank reference
- For larger credit requests: financial statements or a credit bureau report
The goal isn't bureaucracy for its own sake — it's genuinely assessing whether this specific customer has a track record of paying on time, not just good intentions or an exciting order size.
Setting Credit Limits That Make Sense
Rather than applying the same credit limit to every customer, base it on verifiable information: trade reference feedback, credit history, and reasonably, the size and pattern of the customer's actual order activity. A practical, common approach:
- Start conservative with new customers — a modest limit and standard terms
- Increase both gradually, specifically after a genuine track record of on-time payment is established
- Avoid large initial credit extensions to unproven customers, regardless of how promising the relationship looks at the outset
Standardizing Payment Terms
Net 30 is the most common default term across most industries, but the specific number matters less than consistency. Rather than negotiating unique terms for every customer, a workable structure offers one or two standard options — for example, Net 30 as the default, with Net 15 reserved for higher-risk accounts. Genuine exceptions should be deliberate decisions, made consciously, not simply whatever a persuasive customer happens to request in the moment.
The Biggest Mistake Businesses Make
This is worth stating plainly, because it's a genuinely common, costly pattern: the highest-risk moment to skip a standard credit check is precisely when a new customer's order is large and exciting — not when it's small and unremarkable. Large, high-profile new accounts are disproportionately represented in bad-debt write-offs, specifically because normal diligence gets bypassed under the pressure or excitement of not wanting to slow down or risk losing the deal. The size of an opportunity is not a substitute for verifying the customer can actually pay for it.
Reviewing and Adjusting Over Time
A credit policy isn't a one-time decision at first contact — credit limits and terms should be reviewed at least annually, and specifically whenever a customer's actual payment behavior changes meaningfully:
- Consistently early or on-time payment → a reasonable case for increasing their credit limit or offering better terms
- Payments starting to slip later → a signal to tighten terms or reduce the limit before a larger problem develops, not after
FAQ
Business name and legal structure, time in business, trade references (other vendors the customer already has credit relationships with), a bank reference, and for larger credit requests, financial statements or a credit bureau report. The goal is assessing genuine ability and history of paying on time, not just intent.What should a basic credit application ask for?
Base it on verifiable information — trade references, credit history, and reasonably, the size of a first order — rather than a flat number applied to everyone. A common practical approach: start new customers with a conservative limit and payment terms, and increase both only after a track record of on-time payment is established.How do you decide on a credit limit for a new customer?
Not necessarily, though standardizing around one or two options (like Net 30 as default, Net 15 for higher-risk accounts) is generally easier to manage than fully customized terms for every customer. Genuine exceptions should be deliberate decisions, not just whatever a customer happens to ask for in the moment.Should every customer get the same payment terms?
Skipping the standard credit-check process specifically because the opportunity feels too good to pass up or too urgent to slow down for. This is genuinely the highest-risk moment to skip diligence, not the lowest — large, exciting new accounts are disproportionately represented in bad-debt write-offs precisely because normal process gets bypassed under pressure.What's a common mistake businesses make when extending credit to a large new customer?
Consistently, with a clearly defined process for exceptions rather than ad hoc case-by-case decisions. Inconsistent credit decisions — extending generous terms to one customer while requiring upfront payment from a similar one — create both genuine collection risk and a real perception of unfairness that can damage other customer relationships.Should a credit policy be applied consistently, or case-by-case?
At least annually, and specifically whenever a customer's payment behavior changes meaningfully — either consistently paying early (a case for increasing their limit) or starting to pay late (a case for tightening terms before a larger problem develops).How often should credit limits be reviewed for existing customers?
Conclusion
A credit policy's real value isn't in rejecting bad customers — most credit applications are genuinely fine — it's in catching the specific minority that would have become a collections headache or a write-off, before that risk was ever extended in the first place. The discipline to apply the same process to an exciting new account as a routine one is precisely what separates a business with manageable AR risk from one that discovers its exposure only after the money is already owed.
Want your credit and collections process built around real risk management, not just hope? Our Finance Operations service handles exactly this. Book a free consultation to talk through your current approach.