Credit_risk_virtual_bean_counters

Earlier this month, we talked about extending credit to your customers.  We hinted that it was an all “pro” piece and that there would be a follow-up “con” piece.  That’s what today’s article is about….with a twist.  We’re going to assume that if you have done your due diligence, there are no cons.  Instead, we would propose four things to consider BEFORE you extend credit to your customers.  

1.  It seems redundant, but yes, you’ll have to do a credit check.  Now it’s up to you, depending on how your firm does business, how deep you want to go with the research, or what other considerations you might have.  You might ask for bank statements, a DUNS number, some vendors who already extend credit to you who are willing to take a call to speak about your credit history.  Find out how long they’ve been in business.  You might ask for a personal credit report if you feel that’s necessary.  While there’s nothing wrong with a culture that puts trust in a handshake, we would borrow a phrase from an American leader: “trust, but verify.”  As long as you are comfortable with what you see (past performance is often a good predictor of future results) then you can and should extend credit.  If you’re not, have a conversation and state your concerns.  Perhaps they will be able to give you some context that will give you more comfort (or send you running for the hills).

2.  Make sure you have the operating capital to fulfill what you’re willing to extend in credit.  If you have a product-based business, do you have enough working capital (you’ve heard us hit the cash-flow drum plenty) to fulfill an order on credit from this customer?  If you’re a service-based business, do you have the human capital to execute a given project while waiting for payment?  If you don’t, not only will you displease the customer, you could grind your operations to a halt.  This also means you shouldn’t throw your smaller accounts under the bus to please one big customer.  That’s not just a credit consideration, that’s just common business sense. 

3.  Handle the “what-ifs.”  Make sure you have policies and procedures about how and when you get paid, and what happens when you don’t. More importantly, make sure you have clearly communicated this to your customer.   A good rule of thumb is anything delinquent over 180 days is not going to get paid and might as well be sent to collections.  Anything prior to that can be handled with phone calls, emails, etc.  Make sure that you have it clear with your customer what delinquency can do to current order fulfillment.  Also decide if you want to charge interest if amounts are overdue more than 60-90 days.

4.  Always be reviewing.  First, make sure you have systems in place to monitor accounts receivable, contacting any customer the day their account is past due to clear up any misunderstandings. Secondly, correlate the extension of credit to the customer’s buying habits.  Has this greatly improved your relationship (ex: customer now orders more from you) or has it created an inequality (ex: customer orders exact same amount, but now takes longer to pay, often just before interest charges kick in).  If it’s the former – great – and have a conversation to see if there should be more credit extended (if it makes sense for your cash flow).  If it’s the latter, consider having a discussion or winding down the credit line: your customer is now using you as an unpaid line of credit, and you have to decide how much sense that makes for your company (and keep in mind, sometimes it does!).

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We think that if you look at our article which discusses why you should extend credit to your customers, and take to heart the suggestions we put forward in this piece you will have a very strong credit policy. A strong customer credit policy is one of the keys to powerful cash flow management for your business, which always creates more options for all sorts of great things!