Credit policies help govern the lending or credit activities of an organization. This relates to goods or services extended to customers on a credit basis. There are different types of credit polices which can affect the efficiency and cash flow of an organization.
Credit policies represent the guidelines and rules established by top management to govern or oversee the organization's credit department and it performance. This can include credit or loan qualification requirements, loan amounts, types of customers, collateral requirements and applicable interest rates.
Credit policies can be based on the business industry. Automotive, home, academic, retail, wholesale and credit card lending all may have different credit policies. Tight credit policies refer to conservative or restrictive guidelines in the extension of credit. Loose policies allow for more freedom or flexibility. A given business, for example, may focus more on debt collection instead of credit investigations and analysis.
The significance of credit policies can be realized in the operational efficiency of credit departments. This is due to a reduction of ambiguity over how to proceed in their functions. Written guidelines allow for clarity and help to provide instruction. Credit policies can also help improve a company's cash flow, depending on the policy type. Tight credit polices can reduce instances of loan default and speed up accounts receivable turnover, thus increasing cash flow.