Most companies that sell products or services to customers have to offer payment terms - the option to pay invoices in net 30 to net 60 days. Many customers will only do business with you if you offer these terms. Some companies may pay late with many days past due. Others might be happy to take your product or service and never pay at all.
Determining creditworthiness of the client
Some customers deserve credit and others do not – how do you determine who is creditworthy? Offering terms can create cash flow problems for companies that do not have sufficient reserves. This issue gets more complicated if you sell to clients that either pay late or do not pay at all.
It is important to note that there is no guarantee that all of your customers will pay on time or at all. However, by following some simple steps, you can minimize the chances of working with bad customers.
Step 1: First have every customer fill out a credit application. It does not need to be a lengthy form, but it should include their business name, address, contact information, and a list of three to five credit references. A “credit reference” is a company that has recently offered terms to them.
Step 2: Call references of your customer and ask about the payment habits. Also, get a commercial credit report on your customer. You can get them from Dun and Bradstreet, Experian, and Cortera. They sell credit reports that include different levels of information at different prices.
Good questions to ask these references include:
- how long the business or supplier has extended credit to the customer;
- the credit or purchasing limit the business or supplier has extended the customer;
- when the customer’s last purchase was and the amount; and
- how many times the account has been late.
Dun and Bradstreet offers multiple business credit scores. Its Paydex score, which measures payment history, ranges from 1 to 100, with higher scores reflecting better credit. A score of 80 to 100 means your business represents the best credit risk.
Equifax also has multiple business credit scores, each one using different ranges and representing a different element of risk. In at least one of these calculators, a lower score actually means your business has had stronger payment performance.
Step 3: Evaluate the information from your calls to your prospect’s suppliers and from the credit report. Many credit reports include a recommended credit line as a reference to help you determine if you should offer credit and how much credit you should offer. The amount of trade credit you offer should be close to the average of their credit lines. If you are making a large, important sale you may want to buy reports from more than one company to help ensure you have a more complete financial picture of your prospective client.
If you want to offer terms but cannot because you cannot afford to wait 30 days or more to get paid then you can consider factoring financing.
This solution will help you finance your open invoices from creditworthy customers, alleviating cash flow problems. Factoring companies can help evaluate the creditworthiness of your customers and their invoices enabling you to outsource part of the credit function to a company that reviews customer credit.
The Bottom Line
A business owner should always be monitoring business credit or even personal credit. It might not be at the top of your priority, but it is essential to receive funding. To build up a strong profile you need to monitor your personal credit report too. The earlier you get started, the better your position when your business is in need.