Should Your Business Extend Credit? Ask These 5 Questions First.
by Erica Nelson on November 20, 2014
The most secure way to do business is to require prepayment before you render any services or send any product. However, in many cases, this can keep your company from capturing as much business as working on a net 30 or net 60 basis. In some cases with large orders, it can be worth the risk to extend longer payment windows. But, when you extend credit, there is always a risk involved. When choosing whether or not to extend credit to any new client, ask a few questions first:
1. Do you have vendor references I can check?
Does the company have a history of paying their bills on time? While a history of prompt payment is not a guarantee that they will continue the pattern in the future, a history of paying late should give you pause.
If the company is new and does not have any vendor references to send, consider having a cash on delivery agreement for the time being. After six months or a year of doing business, you will have a better idea of their abilities to pay in full and on time.
2. May I perform a credit check?
Credit reports are not just for consumers. Experian, Equifax, Dun & Bradstreet and others offer reports on the payment histories of businesses, as well. According to Equifax, as many as 40% of all small businesses periodically experience cash flow problems. Getting third party information about a company’s history can help you minimize your risk when extending credit.
3. What is your company type?
Are they a corporation, partnership, or sole proprietor? The type of company helps you determine not just risk but what their obligations will be if the company fails. A sole proprietor, for instance, is personally responsible business debts, while a corporation will have several people accountable.
4. Can you sign this credit agreement?
It can be tempting to verbally state that you’ll collect payment at the end of the month. But, if payments do not come in, you have less protection than if you had documentation in place. If legal action becomes necessary, documentation of the debt should be attached to bolster your claim. Make your payment and credit terms a part of your contract with every new client and include them with every invoice.
5. How much credit can we afford to extend?
The last question is one to ask your own accounting department. Examine your cash flow and determine how much of your money you can afford to have uncollected for a month or two at a time. When you have extended credit lines that hit that total, it is time to stop allowing new credit until your immediate cash flow increases. This way, you aren’t at risk of being unable to pay your bills if your client doesn’t pay theirs.
Offering your clients credit can substantially increase your business revenue. By balancing the risk with the greater rewards, you can help your business continue to grow while minimizing the chance of significant losses.