Credit Policy, Investigation, and Risk Assessment
What a credit policy contains
A written credit policy defines credit standards, terms, credit limits, approval authority, documentation, review cadence, and escalation rules. It should state maximum exposure by customer and by portfolio, and define acceptable security (guaranty, letter of credit, UCC filing). Procedures turn policy into steps: application, investigation, decision, documentation, and monitoring.
Investigation sources
- Credit application and signed authorization to obtain credit reports.
- Trade references: ask for high-credit, recent, and comparable-size suppliers.
- Bank reference: average balance, borrowing relationship, and returned items.
- Commercial credit bureau report: payment history, scores, liens, judgments, and bankruptcy.
- Financial statements and tax returns, with a signed personal guaranty where appropriate.
- Public records: UCC filings, mechanics liens, judgments, and corporate status.
Risk assessment
The 5 Cs - character, capacity, capital, collateral, and conditions - remain a useful checklist. Capacity (cash flow) usually matters most; collateral matters most when capacity is weak. A credit limit should reflect the customer's ability to pay, not the size of the order. Review limits at least annually and sooner on adverse news.
Worked example
A new customer requests $250,000 of open-account terms. Financial statements show $80,000 of monthly operating cash flow and $60,000 of existing debt service. Discretionary cash is about $20,000 per month. A 30-day exposure of $250,000 is far beyond what one month's cash flow can support. Counteroffer: a $75,000 limit with a personal guaranty and a UCC-1 filing, reviewed after six months of on-time payments.
Traps
Relying on one trade reference supplied by the customer; accepting stale financials; failing to check UCC filings and judgments; confusing a credit limit with an order limit; and not documenting the decision rationale.