Establish Your Credit Policies
The first guideline for setting up your company's credit policies is to take a look at other businesses just like yours. If you work in an industry that has pretty standard customs, you have a solid starting point from which to build your own credit rules. For example, most accountants send out bills after they've performed services, and wait for their clients to send checks. Pretzel stands, on the other hand, expect instant cash payment before they'll hand over the snack. Retail stores often accept credit cards, checks, and cash. Car dealers take a down payment and let the customer pay the balance over time, with interest. Your credit policies will be based on the kind of business you run, as well as the kinds of customers you have.
Many professional service companies use cash basis accounting systems and bill their clients for services. Technically speaking, using the cash basis means there is no accounts receivable account, since you don't record transactions until money changes hands. Practically speaking, you need to keep track of who owes you money, and how much. In these cases, you record the sale and the receivable on your books, but the sale would not count for tax purposes until payment was received.
Once you decide to offer credit, you need to figure out what types of credit you want to extend to your customers. The first level of credit is accepting checks and credit cards from customers at the point of sale. This practice offers a convenience to customers without increasing your risk of loss to an unacceptable point. Will there be times when a check bounces or a credit card payment doesn't come through? Yes, but those are typically relatively uncommon occurrences, especially with electronic, on-the-spot approval available. On your books, these transactions are recorded as cash sales, because you receive payment at the time of sale.
Level two is typically used by businesses offering professional services, such as consultants. The norm for these types of firms is to bill clients once a service has been performed. The client then has thirty days to mail in payment. For transactions like these, make an entry to accounts receivable when you record the sale.
The next level of credit usually involves business-to-business product sales, and its terms are a little more involved. This is commonly called trade credit, and it is the version most strongly dictated by industry norms. Trade credit comes with its own lingo, which is fairly standard across industry lines; you need to familiarize yourself with the terms if you plan to offer this option.
Understanding Common Trade Credit Terms
When you see credit terms included on an invoice, they look like a secret code: 2/10, n30. That “code” has a simple translation; it means that the customer can take 2 percent off the balance if she pays within ten days of the invoice date, or she can pay the full balance within thirty days.
Here's the breakdown. The first number (the 2 from the example above) is the discount percentage. This discount is used to encourage customers to pay quickly, which is an advantage for your cash flow. You can set your early-pay discount at whatever level you like, but it should be along the same lines as industry standards.
The second number (the 10 in the example) refers to the time limit for the early payment discount. Again, you have some flexibility here. You can set the time frame, usually for anywhere from five to twenty days, based on your cash-flow needs. Why five to twenty? The bottom limit is five, because it will take time for your customer to get the invoice and cut a check, and a little more time for you to receive payment. The top limit of twenty goes with a normal payment turnaround time of thirty days; any closer to the end date and you'll end up in arguments with a lot of customers.
The “n” stands for “net.” In this instance, net means the stated net amount due. Essentially, it's the bottom line of the printed invoice, however much that is. The final number (the 30) stands for the final acceptable payment date, measured by the number of days from the invoice date. So, for a $100 invoice dated June 1 with 2/10, n30 terms, the customer could either pay $98 by June 11 (ten days from June 1) or $100 by July 1 (thirty days from June 1).
Where Can You Find the Industry Standards?
It used to take quite a bit of legwork to learn the inside scoop on industry practices, but now a simple click of the mouse or quick trip to the library can get you plenty of information. Some of the best information sources include:
Your industry's trade association
The U.S. Small Business Administration
SCORE (Service Corps of Retired Executives)
In addition to these more official channels, you can get the direct scoop from other small-business owners in your area. Even if they're not in the exact same industry (i.e., they aren't your direct competitors), you can get an idea from them about the way similar companies conduct business.