Credit: extending it wisely

The speed of business today has necessitated many changes in the way it is conducted. From online stores to the proliferation of credit cards, cash transactions are nearly obsolete — requiring most businesses to extend some form of credit in order to survive.

Extending credit takes many forms. Billing for services performed, providing financing for goods and accepting credit cards are commonplace in modern business. Whatever the form, credit often encourages customers to spend more, builds good customer relations and makes customers less sensitive to price — all of which lead to increased sales.

To realize the benefits, however, business owners must exercise caution when extending credit, especially in this era of home foreclosures and consumer debt exceeding 2 trillion dollars. The first step is developing a credit and collection policy to guide future decisions. The policy should consider several factors, including

  • your cash flow needs, accordingly specifying payment deadlines and finance charges;
  • the cost of credit — if you will be billing clients on a regular basis, for example, you will need to calculate the time it takes to produce invoices; if you accept credit cards, you’ll need to factor in credit card fees of 2 to 6 percent of sales;
  • in what instances and to which customers you will extend credit and how much credit you will offer; and
  • how long your business will attempt collection before turning accounts over to a collection agency or pursuing legal remedies.

Credit policies must comply with state and federal laws governing credit and collections, so it is wise to have an experienced attorney review your policy before executing it.

Second, assess credit risk. Ask customers to complete a credit application indicating business structure (if a company) and business and bank references. Then check those references and the customer’s credit report to assess risk. You can also check public records to see if the customer has any outstanding judgments or liens.

Third, when justified, seek a security interest and "perfect" it. For larger transactions, it’s smart to get a full financial disclosure statement so you can see all the customer’s debts and assets. If you believe the customer can afford the subject transaction with your company, require him or her to provide some collateral against the debt. A UCC financing statement filed with the Department of Financial Institutions in Wisconsin will "perfect" it, letting all other creditors know of your interest in it.

Fourth, consider written agreements. In cases where you will be invoicing for goods purchased or services rendered — even in smaller amounts — written agreements can be valuable not only in clarifying payment terms but also as future court evidence if needed.

Fifth, respond promptly to past-due invoices. If a customer’s payment is past-due, contact him or her right away in person or by telephone. Customers are more responsive to people than they are to reminder notices.

Sixth, when talking with customers about delinquent payments, listen to their reasons explaining why. In some cases, late payments may be due to a problem with the product or service purchased, which you should correct. In other cases, payments may be late because of an oversight or temporary cash flow issue, indicating an aberration. Occasionally, late payments may signal growing financial problems for your customer and a need for you to curb or perhaps temporarily suspend credit privileges.

Seventh, don’t react emotionally when listening to your customers’ excuses. Instead, calmly request a payment date and amount.

Eighth, cut your losses. If you see warning signs that a customer is experiencing significant financial problems — payments become later and later, civil judgments accumulate or substantially more credit is requested — it may be time to insist on cash up front or suspend your business relationship, at least for a time.

In the end, customers are only customers are long as they are actually paying for goods and services. And businesses are only in business as long as they can turn a profit — or at least break even.

Reprinted with permission from the River Valley Business Report, Spring 2008.

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