How to write a credit policy that prevents bad debt

A credit policy is the written set of rules that governs every credit decision: who can buy on terms, how much they can owe at once, and what happens when they stop paying. It prevents bad debt by replacing one-off judgment calls with consistent rules applied before any invoice goes out. The clearer the policy, the less cash you tie up in customers who were never going to pay.

Most bad debt does not come from one catastrophic default. It builds quietly, from limits that were never reviewed and terms that drifted because nobody wrote down the rule. A credit policy fixes that by making the decision boring and repeatable.

What a credit policy should cover

A workable policy answers the questions that come up every time a new customer wants terms, so nobody has to improvise. At a minimum it should cover:

• Standard terms. Your default payment window, usually net-30, and when longer terms are allowed.
• Onboarding requirements. What a new customer must provide before terms are granted, such as financials, trade references, or a personal guarantee.
• Credit limits. How the starting limit is calculated and the maximum any single account can owe.
• Approval authority. Who signs off on a given limit, and the amount at which a decision escalates to a controller or the CFO.
• Risk tiers. How customers are grouped by risk, and what limits and monitoring each tier gets.
• Suspension rules. The conditions that trigger a credit hold or a switch to prepayment.
• Review cadence. How often the policy and individual limits get re-examined.

Write it so a new analyst can apply it without asking, and leave room to handle a strategic account that does not fit the template. The point is consistency, not rigidity.

Setting credit limits and approval rules

The credit limit caps how much a single customer can owe at one time. It is your main lever against concentration risk, the danger of too much cash sitting in one account that might not pay.

Set the starting limit from the onboarding evidence: payment history, financial strength, and expected order size. A common rule of thumb is a limit that covers one to two months of expected purchases. Hold it lower for a brand-new account until they have paid a few invoices on time.

Then tie approval authority to the size of the risk. The bigger the limit, the more senior the sign-off. A simple ladder works:

• Up to $10,000: a credit analyst approves on a clean credit check.
• $10,000 to $50,000: a credit manager reviews financials and trade references.
• Above $50,000: the controller or CFO signs off, with documented reasoning.

These numbers are illustrative. Set yours to the size of your typical deal. What matters is that the threshold is written down, so the answer does not depend on who happens to be asking.

Credit policy template

Copy this into a document and fill in the brackets. It is deliberately short. A policy people actually read beats a thorough one nobody opens.

[Company name] credit policy

1. Purpose
This policy sets the rules for extending credit to customers and managing
the risk of non-payment.

2. Standard terms
Default payment terms are [net-30]. Terms longer than [net-45] require
[controller] approval. New customers begin on [prepayment / net-15] for
their first [two] orders.

3. Onboarding requirements
Before terms are granted, a customer must provide:
- A completed credit application
- [Two] trade references
- [Most recent financial statements, for limits above $X]
We run a credit-bureau check on every applicant requesting terms.

4. Credit limits
The starting limit equals [one to two months] of expected purchases,
subject to the approval ladder below. No single customer may exceed
[X% of total receivables] without CFO approval.

5. Approval authority
- Up to [$10,000]: credit analyst
- [$10,000] to [$50,000]: credit manager
- Above [$50,000]: controller or CFO

6. Monitoring and holds
A customer is placed on credit hold when:
- An invoice reaches [60] days past due, or
- Their balance exceeds their approved limit, or
- Their credit rating is downgraded.
New orders pause until the balance is cleared or the limit is revised.

7. Review
This policy is reviewed [annually]. Individual limits are reviewed when an
account pays late, places an order [50%] above its normal size, or its
credit rating changes.

Approved by: [Name, title, date]

When to use this: as the baseline for a first policy, or to replace an informal practice that lives only in people's heads.

The decision rules behind the template

A template is only as good as the rules it encodes. Three decisions do most of the work.

Grant, limit, or refuse. For each applicant, the policy should resolve to one of three outcomes: full terms, a smaller limit, or prepayment until trust is earned. A clean credit check and solid references point to terms. A thin file or weak financials points to a small limit or prepayment. You are not predicting the future, you are making a defensible decision with the evidence in front of you.

When to hold. A credit hold is the policy's teeth. Define the exact triggers (days past due, balance over limit, a rating downgrade) so a hold is automatic, not a confrontation someone has to start. That protects the relationship, because the rule applies to everyone equally.

When to escalate the limit. A customer who pays every invoice early has earned a higher limit. Bake that in, so good payers get rewarded and the sales team is not slowed by a stale cap.

Linking credit terms to collections

A credit policy and a collections process are two halves of the same job. Credit decides how much risk to take before the invoice. Collections recovers the cash after it goes overdue. The tighter the first, the lighter the second.

The link is the data. When collections sees a customer slipping past terms, that signal should flow back to credit and trigger a limit review before the exposure grows. When credit tightens a limit, collections should know to chase that account harder. Set payment terms that match each customer's risk tier, and the two functions reinforce each other instead of working blind. The same upstream discipline is what lets you prevent late payments before they ever reach a collector.

Reviewing and updating your policy

A credit policy goes stale the moment you write it. Customers' finances change, and a reliable payer can become a slow one over two quarters.

Review the written policy at least once a year against what actually happened: which accounts went bad, and whether the rules would have caught them sooner. Review individual limits more often, whenever an account pays late, places a much larger order, or its credit rating moves. The aging report, read account by account rather than in aggregate, surfaces most of what needs a second look. A policy that never changes is not stable, it is unmonitored.

How Rex operationalizes your credit policy

Writing the policy is the easy part. The hard part is applying it the same way to every account, every day, without anyone forgetting. That is the gap where bad debt grows.

Rex is an AI accounts receivable agent that enforces your credit rules in practice across the whole ledger. It applies your terms to every invoice, watches each account's balance against its limit, and flags the moment a customer crosses a hold trigger or starts slipping past terms. When a borderline case needs a real decision (a strategic account asking for an exception, a limit that should move), Rex escalates it to a person with the history attached. The routine enforcement runs continuously so your team spends its judgment only where the money is genuinely at risk.

See how Rex turns your credit policy into rules that run themselves.