Written by Effective credit management is more than just a back-office function; it’s a strategic tool that can drive business growth. For small business owners, managing credit effectively means protecting cash flow, reducing bad debt and strengthening relationships with customers and suppliers.
In this guide, we discuss the role of credit management in business success, present three practical strategies for managing credit and provide actionable steps you can start implementing today.
Understand how credit management can make or break your business
In any business, success depends on how effectively you can get cash in the door, and credit management supports that goal.
Credit management is the process of:
- Granting credit to customers
- Setting terms for payment
- Collecting the money customers owe
It’s more than a routine task — it’s a strategy for ensuring your business has the working capital needed to operate and grow.
Poor credit management leads to cash flow issues and, potentially, even business failure. In fact, according to an Intuit study cited by CPA Practice Advisor, 61% of business owners struggle with cash flow, and nearly one-third (32%) can’t pay vendors, pay back outstanding loans or pay themselves and their employees due to cash flow issues.
Small businesses — especially those running on thin margins — must manage their credit to support growth and minimize risk. Here are five steps to do just that.
1. Establish clear credit policies
The first step in effective credit management is setting clear and transparent credit policies.
The Chartered Institute of Credit Management (CICM) defines a credit policy as “a set of rules that businesses and organizations use to manage the extension of credit to customers and clients.”
Creating a credit policy means defining who qualifies for credit, how much credit you’ll extend and under what terms.
Your credit policies should include:
- Eligibility criteria. Define the financial health and creditworthiness indicators for customers before granting credit. Will you run business and personal credit reports or ask for references? These steps help vet customers and determine whether they have the ability and willingness to repay debts.
- Payment terms. Be specific about payment timelines (e.g., Net 30, Net 60), and communicate these terms clearly to customers in writing.
- Penalties for late payment. Set late fees or interest on overdue accounts to encourage timely payments. Keep in mind that state law may cap interest and late fees. For example, a state may cap late fees at no more than 10% of the original invoice.
- Discounts for early payment. Consider offering small discounts for customers who pay invoices ahead of the due date as an incentive for prompt payment. For example, you might offer a 2% discount if the customer pays within 10 days of the invoice instead of the standard 30 days.
Having these policies in place (and ensuring your customers understand them) reduces future collection disputes.
2. Use accounting software
Modern accounting software includes several features to automate invoicing customers, tracking payments and collecting outstanding receivables.
Key features to look for in your accounting software platform include:
- Automated invoicing. Schedule and send invoices automatically to avoid delays.
- Accepting payments. Make it easy for customers to pay you by offering multiple payment options, including credit cards, ACH, PayPal or Stripe.
- Payment tracking. Monitor which invoices have been paid and which are outstanding.
- Alerts for overdue payments. Receive notifications for overdue accounts and set up reminders for customers.
If your business has more extensive credit management needs, consider separate credit management software to assess customer risk and suggest credit terms. These tools can integrate with your accounting software and provide data-driven insights into customer payment patterns, helping you make more informed decisions.
3. Closely monitor accounts receivable
Accounts receivable (AR) refers to the money customers owe to your business for purchasing goods or services on credit. If you don’t manage AR properly, overdue receivables can cause a liquidity crisis, making it difficult to cover operational costs.
The fact is, the longer an invoice goes unpaid, the less likely it is to be paid. A 2022 study by Due found that if a customer hasn’t paid an invoice within 90 days of receipt, there’s only an 18% chance of that invoice ever being paid.
Here are some practical steps to manage receivables:
- Regularly review AR aging reports. An aging report categorizes your receivables based on how long they’ve been outstanding. Review this regularly to identify potential problem accounts before they become uncollectible.
- Send reminders before due dates. A friendly reminder before a payment is due can prompt customers to prioritize your invoice.
- Follow up on overdue accounts. Implement a process for following up with customers who have overdue payments.
- Be flexible but firm. If a customer has a legitimate reason for delay, consider granting a short extension or negotiating a repayment plan that works for both parties. This keeps the relationship intact while still recovering the debt.
Remember, effective credit management isn’t something you can leave to chance. By establishing clear credit policies, using the right tools and staying on top of outstanding receivables, you can avoid lost revenue and protect your cash flow.