When you, as a business, extend credit to a customer, you are actually lending them money to pay for the product or service that you sold them. However, unlike a bank, you do not make money on this loan; in fact, you lose money on it. Some of your clients may even see this “vendor financing” as a source of working capital for themselves. How can you get the most out of this situation? Basically, if your business clients treat you like a bank, then you should think and act like a banker.

The key points are:

1. Know who you are dealing with
2. Gather information about the business, its finances, and its payment history.
3. Establish a credit limit for the customer.
4. Consider getting additional security for large or risky transactions
5. Monitor payment performance and review credit terms based on experience and new information.

Know who you are dealing with.

Regardless of the amount of the sale, you should avoid the possibility of fraud, especially if it is an out-of-town customer placing an order by email or online. Generally, these transactions would be paid by credit card rather than billing the customer. If you must bill, obtain the required information about a business from a credit application or credit reporting service as described below. If not, at a minimum, do an internet search for the company and verify that it exists by calling the contact phone number provided on the site. If you cannot locate the business or if the phone number does not exist or is not answered, be careful.

Gather information about the business.

Get essential information about the business, its finances and its payment history from appropriate and available sources.

• Credit reports from national reporting services like Dun & Bradstreet or Experian. You will pay for these reports and a subscription to a service is worth considering if you check in with clients frequently. Some accounting or credit management software packages have this built-in capability. Small, private, or start-up businesses may not have much information from these sources, so you will need to apply for a credit application.

• Credit applications give you the opportunity to gather detailed information as well as permission to contact references. This document may also allow you to agree to its terms and conditions. If you want to charge a late fee on overdue bills, the app is a place to put that notice, giving you a legal basis to do so. It is probably not worth it (or appropriate) to apply for a loan from large public companies, but they should have enough information available from public sources. Tip: Any customer who refuses to complete a credit application in its entirety probably has something on their credit history that they are not proud of. This is a warning sign – watch your situation very carefully.

• Credit references and other relevant company information are sometimes provided through a customer-prepared credit reference statement rather than a credit application. This may be sufficient depending on the amount of credit requested.

• Reference checks must be performed for all major credit applications. It is appropriate to fax a credit reference form to a business reference and wait for them to complete it, although a phone call to inform the credit department would be appreciated. Compare what the references tell you to what was provided on the application or credit report. Discrepancies need to be investigated.

Set a credit limit for the customer.

Establishing a credit limit is a complex and critical process to balance customer requirements with their ability to pay and their confidence in that ability.

• Credit requirement. The first step is to understand how much credit the customer needs today (for the first purchase) and how much additional credit will be required for future sales. For example, a customer who makes a one-time purchase of $ 10K requires a limit of $ 10K, but spending this same amount over the course of a year may require only a limit of $ 2-3K, since the first invoice must be paid before of the third. one is issued. If not, you have a slow paying customer problem.

• Ability to pay. One of the fundamental principles of credit is understanding a borrower’s ability to pay. Compare the amount of the loan application with your cash flow, company size, existing debt load, etc. Another consideration is your industry. Certain types of businesses (restaurants, for example) have a much higher risk of default than others. Finally, check your payment history with other providers according to the terms. You may want to be conservative in setting a limit for slow paying customers or risky business customers to minimize your exposure. Remember, you can always change the limit up or down as new information becomes available.

• Default limit. One way to simplify this process is to establish a predetermined line of credit. You can bypass the limit setting process for customers who need a line of credit less than their predetermined amount and who have been verified through the data collection portion of your credit review. You should set a default credit limit based on the amount of risk you can tolerate as a business and your profit margin in a typical transaction. That is, if a customer does not pay a bill of, say, $ 1,000, would that affect their ability to operate your business?

Consider getting additional security.

For particularly large or risky transactions, you should consider getting additional security for the transaction. Depending on the situation, some options include:

• Personal guarantee. It is common practice to ask a small business owner to personally guarantee the business debts. The owner must sign a document accepting the guarantee. However, you should check the owner’s personal finances and credit history before doing this. If your credit is poor and / or you don’t have significant personal assets, then the collateral may prove useless when you try to enforce it.

• Presentation of UCC. If the sale involves tangible property, you can register your security interest by filing the Uniform Commercial Code (UCC) with the Secretary of State for your state. This is common practice for installment sales or leases, but it also applies to any type of financing and gives you the ability to repossess the property in the event of default. The filing remains in effect until the debt is paid in full, at which point it would file for a rescission.

• Credit insurance. This approach is typically reserved for very large transactions where you are concerned that the buyer may file for bankruptcy. I often see credit insurance for large transactions in the retail sector. Credit insurance is expensive (usually between one-half and one percent of the insured amount) and requires the insurer to do its own risk assessment before issuing a policy. However, it protects you from the catastrophic effects of a customer default. Remember, this insurance does not cover late payments or refusal to pay due to disputes.

Monitor performance.

Sound business practices demand that you pay attention to your customers and their behavior. Some of the credit-related activities include:

• Monitor payment history. Do your clients adhere to your payment terms? If your payment behavior changes over time, that could be a sign of financial stress.

• Monitor and enforce credit limits. When customers approach or exceed their limits, you must decide whether it is appropriate to increase the limit or apply it, placing the customer on hold for credit until the outstanding balance is paid. This is always a difficult option for sales-oriented business owners, but you must limit your exposure in a risky situation.

• Periodically review large balances. Concentrating a significant percentage of your accounts receivable on a small number of customers exposes you to risk if one or more of them are unable or unwilling to pay you. Obtain credit information quarterly. Keep an eye out for news about the customer, which can be easily done by setting up alerts on Google.

• Take immediate action if something important changes about a customer. This could be a news report about impending bankruptcy or mail returned as undeliverable. Time is of the essence in these situations.

• Implement a credit and collection system. There are many software applications available to help you monitor customer payments and more effectively manage accounts receivable collection efforts. Some of these are very effective even for smaller businesses.

Remember: you are a business, not a bank. But that doesn’t mean you can’t think like one when extending credit to your customers.