The marketplace is competitive. Prospective customers expect you to extend credit to them. However, is it the right decision for your business?
Offering credit to your customers has its pros and cons. If you choose to do it, establishing the right processes will be critical factors for a successful operation.
Making the Decision
Credit comes in many forms. For example, perhaps you think of checks as cash, but they are a form of credit. Credit cards are, of course, credit. Billing by invoices is a very common credit practice.
Accepting these methods of payment comes at a price. You are trusting individuals and businesses to pay you at a certain point for your goods and services, which they are already using or have used.
The positive aspects of extending credit include:
- Buyers appreciate it, and it encourages loyalty and goodwill.
- More people will become customers because your offering becomes more affordable for them.
- Customers may buy more from you.
- You will be competitive in a marketplace that has come to expect credit.
- You build a reputation as a reliable business, one that is stable and mature enough to extend credit.
- You are telling your customers you stand behind your product.
The drawbacks of extending credit include:
- You need to be able to determine which customers are creditworthy in order to generate a reliable accounts receivable flow.
- Cash flow is dependent on when your customer pays.
- It takes time, paperwork, and phone calls.
- After invoicing, you need to collect the money each month. With some customers, that means pursuing the money aggressively.
- Some customers may react badly to getting reminded they are behind on paying and move to a different supplier.
- Sometimes credit collections means making a settlement in which you lose money overall.
- If you are a small service provider, ask yourself if you need to provide credit. Would an all cash business work for your market and customer base? Offering credit is the norm, but don’t assume you have to do it.
Setting Up Credit Practices
If you decide to extend credit, you need to have a system in place before you take your first order and send out your first invoice. Here are four points to include in your system.
- Determine creditworthiness. Run a credit check on each business before you offer credit. Just because an individual is pleasant and hardworking doesn’t mean they are worthy risks.
- Set up guidelines and stick to them. Mark your invoices with the due date. Show at which point it will be considered delinquent. Put the contact information for your accounts receivable staff clearly on each invoice. This encourages customers to call when they have questions or need help.
- Set up an accounts receivable department or hire out the work. You want it professionally run, with good communication among customers, accountants, and management.
- Create a collection plan and implement it. Get all the pertinent information from your customer before you start doing business. Send out invoices on time. Give each customer a copy of your payment policies, which includes late fees and penalties. Get everything in writing in case the collections go to court later.
Knowing Credit Laws
You are required to comply with all consumer credit laws. They dictate how you advertise interest rates, how you handle claims when there was a mistake in billing, and the method you use to collect debts. ScoreInfo, created by FICO, offers an excellent overview of consumer credit laws.
There are many aspects of the debt collection process that consumer credit laws and the Federal Trade Commission (FTC), regulate. Be sure you keep on the right side of them.
Dealing with Collections
Your credit system needs to include a process for dealing with a customer who can’t or won’t pay a bill. Your procedure needs to take into consideration the local consumer protection agency rules for debt collection and well as FTC guidelines.
Collecting a debt can be time time-consuming and expensive. In some cases, it is just easier to write it off. For example, if a customer declares bankruptcy, you may or may not be eligible to collect even a small percentage of what they owe. If you get awarded money, you still may need to pursue the customer to collect it.
What's the Takeaway?
It is easier to prevent the problem in the first place by extending credit wisely. Check out every prospective customer. Be very conservative in your choices. You are not required to extend everyone credit. While most customers come to expect credit, it is essentially a benefit from your business to theirs, and not merely a right.