In the B2B world, particularly in light of today's economy, there’s always the question: Do I extend credit to my customer? Do I take the risk to increasing sales and or also take the risk of losses for nonpayment? There are three questions to ask yourself when considering producing and shipping product to your customer and extending open terms.
1) Why should I extend credit?
2) How do I extend credit?
3) What steps do I take to extend credit?
Why – In today’s business climate, it seems that everyone is more interested in price and shipping and no one is really trying to build business relationships. In that light, it is very difficult to start a business relationship out of the shoot by asking the client to pre-pay and order or have the order ship COD. In essence you are saying, “Thank you for the order but I don’t trust you.” And that is what extending credit is – a matter of trust. They trust you will produce and ship their order on time and you trust them to pay you for that product on time. The advantage of extending credit enables the opportunity for new orders and increased sales.
How – There are many things to consider when making a decision to extend credit to a client. The most important is that you know as much about your client as possible. This is achieved through multiple of resources and avenues. Much of this will be covered in what steps to take.
The resources to consider would be the credit application itself, the credit reports and believe it or not, Google Earth. The application tells you about them (name, state address, and the usual you would see on any application). The credit report is going to tell you how they pay, number of trade creditors, if there any collections, tax liens, judgments, etc. If one knows how to really read a credit report, they can also get an idea of the sales volume of their client.
In how to extend credit you need to have a completed application, run your report and then analyze and review the report and make your credit decision form there. Many companies check references but I have found this to be a waste of time and not very helpful. Your client is not going to supply you with a reference that they may pay slow or have a bad experience debt with.
We have been using Google Earth for several years now and it is standard procedure. We do this to confirm both the business and the address, check out the physical environment of the business as well as get an idea of what the economic climate may be in that general area. An example of its use is that a few years ago, a client asked us to collect on an account. When we ran a Google Earth check and we found the address to be an empty lot.
Aside from using Google Earth, do you visit you clients at their location? Do you know who their personal banker is and did you seek permission to speak with them? Are there competitors with whom you have a good relationship that could share information on the client?
What – We find it very troubling when we see companies fail to exercise due diligence when they set up a new account and or are selling to customers on open terms. The lazy thing to do is simply require pre-pay on all orders which is not fair to those companies who have good and acceptable credit ratings. The other area where companies get into trouble is to fail to ask for a completed and signed credit application. Note it said signed. If one is completed, yet is not signed, it is worthless as it relates to terms and conditions that may be and should be on your application. Remember, the application is your first line of defense or first step in avoiding future collection or credit issues with your client. Assuming you have a completed and signed credit application, your next step is to run the credit report(s). These reports can be an Experian report, CreditSafe report, D&B (not very reliable for small companies) or if your industry has developed industry specific reports, you can run them there. In today’s world we think it is very critical that you run at least two reports, three if possible.
From these reports you can glean enough information to come to a reasonable and informed decision as to how much credit (if any) you are willing to extend to the client. Once you have reviewed the report, looked at all aspects of the customer’s credit history and determined their credit worthiness, a credit limit is assigned and at that point a letter should be sent thanking them for their interest and the credit limit they have been extended. We would make a final point on the credit limit. It should not always be set in stone and concrete and there should be flexibility to approve orders beyond the limit assigned (unless it is an absolute fixed limit meaning you don’t wish to take any additional risk). The credit limit is there as a barometer if you will and used in such a way to manage your risk while at the same time increasing sales.
Determining the limit is based on a number of factors, the most important of which is your appetite for a potential loss. Always ask yourself how much you are willing to lose in any one transaction. Never extend more than that amount. (See Enron, Worldcom, and many other large companies with tragic credit and collection consequences.)
Having covered the why, how and what, it is important to know what information should be in the credit application for your benefit as well as that of the customer. The application is vital for many reasons the least of which it covers the terms and conditions you as the seller are laying out in order for the customer to do business with you. The following are elements of the applications that should be in place and why:
The obvious in the application is going to be the address, city, state, zip, contact information, payables person, email addresses and such. The other elements and which are vital deal with the terms and conditions.
Venue - Your application should indicate the venue of choice. This is in place so that in the unlikely event you have to sue your customer or pursue them for a debt they owe, your location for the action would be your state, city and county. The last thing you want is to retain an attorney or take legal action away from your venue. You always want the action in your "backyard" so to speak.
Late Fees - Your application should indicate that late fees will be assessed at 18% or the highest rate allowed by law. This does not mean you will actually force them to pay but it provides for leverage if they are past due. For example, if they owe you $500.00 and have late fees of say $30.00, you can tell them you will waive the late fees if they send a payment that day or that week.
Collection/Litigation - This is very important to include in your application as it is a great tool to use when collecting past due debt. If your customer knows they will have to pay the collection fees (assuming a third party collector is used) or if you sue, they will have to pay all legal fees, they are more likely to work with you to pay your debt than allow it to proceed to such a point.
All of these should be written in your terms and conditions so the credit application which legally is a contract is used as a tool to encourage your customer who may be paying slowly, to pay the balance they owe. If you do not have a credit application in your credit arsenal, you can obtain these on line or contact your nearest National Association of Credit Management (NACM) office.
Offering credit terms is a great way to start a solid business relationship, obtain future orders and not merely a one hit wonder account. There are many advantages to establishing credit terms with your customer but in so doing, one must take all the precaution and care when moving forward with this approach. If you are hap-hazard in your credit review and in taking all the precautions, you will most likely end up losing money. As we say in the title, extending credit can be a gateway to sales or a gateway to losses.
Mark Borofsky CCE, CEW is the president of CORE Strategies, LLC a credit management and outsourcing company. If you have any questions regarding credit issues, he can be reached at 316-721-5549 or mborofsky@cox.net.