Selling on credit can help your business grow by attracting more customers and increasing sales. On the flip side, credit also increases your risk and can be a drag on your cash flow unless you have a carefully planned and well-managed credit policy.
In spite of what you may have heard, extending credit is not the best strategy for every business. Your decision about whether or not to allow customers to buy on credit should be based on the kind of business you own, standard practices in your industry and the financial condition of your company. Your banker or trade association should be able to advise you on business and industry norms and your accountant can help you decide if you can afford to offer credit.
Many business advisors recommend that you operate on a cash-only basis if you sell primarily to individuals. You also can offer customers the convenience of credit at relatively low risk and expense by accepting credit card payments. Ask your banker about getting set up to receive credit card transactions.
If selling on credit makes sense for your company, you should develop a policy that sets criteria for evaluating a customer’s credit worthiness, sets forth your credit terms and outlines how you will handle payment collection.
Credit worthiness. The Five C’s of Credit can help you evaluate a customer’s credit worthiness:
- Character – What is the customer’s history and reputation?
- Capacity to repay – Is the customer’s cash flow sufficient to cover the purchase price?
- Capital – To what extent has the owner/customer invested personal resources in the business? This may reflect his or her commitment to the company’s success and paying debts.
- Collateral – What secondary sources or assets are available to insure payment?
- Conditions – What economic conditions or external influences could affect your customer’s ability to pay?
While many business advisors agree that capacity to repay is the most important factor, the relative weight of the five C’s may vary from one industry to another. Again, your banker and trade association can help you determine which factors are most important for your business and industry.
A credit application should provide basic information about your customer’s credit worthiness and request credit reference. It also should include the customer’s authorization for you to get a credit report. Ask your company’s legal advisor to review your credit application and make sure it complies with federal and state credit regulations.
Once you have a signed application, verify that the information is correct, order a credit report on the business and the owners and check the customer’s references. If you are satisfied that the customer is credit worthy, decide how much credit you will extend. It’s a good practice to start conservatively and let the customer “earn” the privilege of a larger credit line.
Credit terms – What time limits will you set for customers to pay for their purchases? Thirty days is somewhat standard for small businesses, yet terms can vary according to your industry, customers, location, transaction size and your own financial position. If you sell to government agencies or accept insurance payments, you should be prepared to wait 60 or 90 days for your money.
Your policy may go through a bit of trial and error before you find a perfect balance between the benefits and risks of offering credit. As your business grows and/or economic conditions change, you may need to modify your policy so that it continues to meet your needs.
Collections – Finally, your credit policy clearly should state how collections on overdue accounts will be handled and what penalties or interest will be charged for late payment.
Collecting what you’re owed requires discipline on your part. You must bill promptly, track payments carefully and follow up quickly with customers who don’t pay on time. Be polite, professional and firm when calling about overdue accounts. American author Edgar Watson Howe wrote, “No man’s credit is as good as his money.” Your company’s success depends on turning your customers’ credit into money.
Darryl Montgomery is the Wells Fargo regional president for Greater Houston.