Credit risk is one of the biggest financial risks in B2B trade. According to the Federation of Finnish Enterprises, bad debts for SMEs average 0.5–2 percent of revenue, and a single large bad debt can jeopardise the entire business. A credit policy is a systematic way to manage this risk – it defines clear rules for who is sold to on credit and under what terms.
What is a credit policy?
A credit policy is a company's internal guideline that covers the entire credit-granting process: assessing the customer's creditworthiness, setting credit limits, defining payment terms, monitoring receivables, and collection. A well-drafted credit policy is documented, known throughout the organisation, and consistently followed.
Without a credit policy, credit decisions are based on individual judgement and case-by-case assessment. This leads to inconsistent decisions, excessive credit risks, and slow decision-making. Sales pressure may drive the acceptance of high-risk customers because there are no clear boundaries.
Assessing customer creditworthiness
Creditworthiness assessment is the foundation of a credit policy. Every new customer and significant credit limit increase must be evaluated before a credit decision is made. The assessment draws on both external data sources and the company's own experience with the customer.
Data sources for creditworthiness assessment:
- Credit information agency report (Asiakastieto, Bisnode) – payment defaults, credit rating, financial statements
- Public financial statements – revenue, profitability, equity ratio, liquidity
- Trade register data – company form, board members, owners, year of incorporation
- Own experience – previous payment history, regularity of orders, quality of communication
- Industry data – general payment behaviour and economic outlook for the industry
- References – other suppliers' experience with the customer
It is advisable to use a scoring model for creditworthiness assessment, where different factors are assigned points and the total score guides the credit decision. For example: credit rating (0–30 points), financial statement ratios (0–25 points), company age (0–15 points), own experience (0–15 points), and industry risk (0–15 points). Over 70 points: standard credit limit. 50–70 points: reduced credit limit. Below 50 points: prepayment or security required.
Setting credit limits
A credit limit is the maximum total outstanding receivables a company accepts from a single customer. The credit limit should be proportionate to both the customer's creditworthiness and the company's own risk-bearing capacity. A single customer's credit limit should not exceed an amount whose loss the company can absorb without serious consequences.
Principles for setting credit limits:
- Set the credit limit in proportion to the customer's creditworthiness and your own risk
- A single customer's credit limit should not exceed 5–10% of the company's monthly revenue
- New customers receive a tighter credit limit, which can be raised based on payment history
- Review credit limits at least annually or when changes occur in the customer's situation
- Document credit limits and their rationale clearly
Defining payment terms
Payment terms are an essential part of the credit policy. They define the payment period, late payment penalties, and potential discounts for prompt payment. Payment terms should be clear, reasonable, and consistent across different customer groups.
Typical payment terms in B2B trade are 14, 21, or 30 days. The EU Late Payment Directive limits the payment term to a maximum of 60 days. A cash discount – for example, 2 percent if paid within 10 days – can incentivise faster payment and improve cash flow. The credit policy also defines the criteria under which a customer may be granted a longer payment term.
Concrete example: If your company offers a 2% cash discount with a 10-day payment term (2/10 net 30), this corresponds to an annualised interest rate of approximately 36%. Yet it can be worthwhile if faster payment significantly improves cash flow and reduces the risk of bad debt.
Receivables monitoring and the collection process
The effectiveness of a credit policy depends on monitoring. Outstanding receivables should be tracked daily and overdue receivables dealt with immediately. The credit policy should include a clear escalation path that defines what action is taken at each stage.
Typical collection process escalation path:
- 1–7 days overdue: friendly payment reminder by email
- 8–14 days overdue: phone call to the customer, investigating the reason
- 15–30 days overdue: formal demand for payment, halting new deliveries
- 31–60 days overdue: final payment notice before engaging a collection agency
- Over 60 days overdue: referral to a collection agency or legal collection
- Credit limit frozen as soon as a significant delay is identified
Invoice financing as a complement to the credit policy
Invoice financing, particularly on a non-recourse basis, is an effective way to complement a credit policy. With non-recourse invoice financing, the financier bears the bad debt risk if the customer does not pay. This means the company receives funds from its invoices and the credit risk is transferred to the financier. It is effectively a combination of credit insurance and financing.
Invoice financing also complements the credit policy by improving the availability of credit information. Financiers assess the creditworthiness of the invoice payer as part of the financing decision, so the company receives an external opinion on its customer's ability to pay. If the financier does not accept an invoice, it may be a warning sign of the customer's deteriorating solvency.
The credit policy can specify that receivables exceeding a certain credit limit must be financed through invoice financing. This caps the risk exposure to a single customer and frees up capital for running the business. According to Euler Hermes, systematic credit risk management reduces bad debts by an average of 40 percent.
Implementing and maintaining a credit policy
Implementing a credit policy begins with an assessment of the current state. Establish current bad debts, the level of overdue receivables, and the quality of credit decisions. Draft a credit policy document covering creditworthiness assessment, credit limits, payment terms, monitoring, and collection. Train the entire organisation – especially sales and finance – to follow the policy.
Steps for implementing a credit policy:
- Assess the current state: bad debts, overdue receivables, current practices
- Draft the credit policy document in a clear and unambiguous manner
- Define credit classes and the credit limits and terms associated with each
- Establish the credit decision process and appoint responsible persons
- Train sales, finance, and management to follow the policy
- Implement monitoring tools and reporting practices
- Review and update the credit policy at least annually
Summary
📌 Summary
A credit policy is one of the most important risk management tools for a B2B company. It consistently defines creditworthiness assessment, credit limits, payment terms, and the collection process. Non-recourse invoice financing complements the credit policy by transferring credit risk to the financier and providing an external assessment of the customer's ability to pay. A well-drafted and consistently followed credit policy significantly reduces bad debts.
