A service center offered net-30 terms to every customer regardless of size, creditworthiness, or order pattern. Their DSO averaged 48 days. Their annual bad debt write-off averaged $95,000, roughly 0.3% of revenue. Both numbers were well above industry benchmarks. The problem was not that they extended credit. It was that they extended the same credit to everyone without differentiation.
Tiered Credit Terms
Different customers deserve different terms based on their credit profile, purchase volume, and payment history. A three-tier structure works for most service centers. Tier 1 (strong credit, consistent volume, reliable payment): net-30 with a 1% discount for payment in 10 days. These are your best customers and the discount incentivizes early payment that improves your cash flow. Tier 2 (moderate credit, newer relationship, or inconsistent payment history): net-15 or net-20. Shorter terms reduce your exposure while still offering convenience over prepayment. Tier 3 (new customers, weak credit, or prior payment problems): prepay, COD, or credit card. No open terms until they establish a track record.
Moving customers between tiers should be based on objective criteria. After 6 months of on-time Tier 3 payments, offer Tier 2 terms. After 12 months of on-time Tier 2 payments, offer Tier 1. Conversely, two consecutive late payments on Tier 1 should trigger a review and potential downgrade to Tier 2.
Setting Credit Limits
A credit limit should reflect the maximum exposure you are willing to accept with a specific customer. The common formula is one to two months of expected purchases, adjusted by credit score and financial strength. A customer expected to buy $30,000 per month with strong credit gets a $30,000 to $60,000 limit. A customer expected to buy $30,000 per month with marginal credit gets a $15,000 to $30,000 limit.
Do not set credit limits and forget them. Review limits annually for all accounts and immediately when triggered by a late payment, a returned check, or negative news about the customer's business. A credit limit set two years ago based on a customer's financial condition may not reflect their current situation.
The Early Payment Discount
Offering 1/10 net 30 (1% discount for payment within 10 days, full amount due in 30 days) is one of the most effective cash flow tools available. The math: a customer who takes the 1% discount on a $10,000 invoice saves $100 by paying 20 days early. Your cost is $100, but you receive the cash 20 days sooner. If your cost of capital is 8% per year, 20 days of $10,000 costs you $44. You spent $100 to save $44, which seems like a bad deal until you factor in the reduced DSO across your entire portfolio. If early payment discounts reduce your average DSO from 45 days to 35 days on $8 million in AR, you free up $880,000 in working capital. At 8% cost of capital, that saves $70,400 per year. The math works at portfolio level even though it looks expensive on individual invoices.
Enforcement
The best credit policy is worthless without enforcement. When a customer exceeds their credit limit, the next order goes on hold until payment is received. No exceptions for "good customers" without management approval. When a payment is past due, the collection process starts on day one past due, not day 15. When terms are violated repeatedly, terms are changed, not negotiated.
This discipline is uncomfortable. Sales reps will push back. Customers will complain. But the alternative is unlimited, unmonitored credit exposure that eventually produces a bad debt loss large enough to wipe out a quarter's profit. Consistent, transparent credit management protects the business while preserving customer relationships because everyone knows the rules.