Extending credit, that is allowing your customers to buy your products and services with the promise of payment later, can dramatically increase your sales in certain industries. Customers tend to buy more product per order and order more frequently from your business if they can pay for those goods and services at a more convenient time. Package deals, case quantities and even a full truck-load of merchandise are more palatable when payment doesn’t have to happen on the spot. And while extending credit can help you sell more product, it can also help your customers better manage their inventory, reduce costs by buying in quantity and better utilize cash during the normal cash flow cycles of their businesses. Extending credit to customers can really be a win-win situation, and in some industries, is necessity if you want to compete in the marketplace.
And for every positive reason for extending credit, I’ll be we can come up with a corresponding negative reason why not to do so. The fact is, if you mismanage your accounts receivable, you’re going to get burned—and in most cases, it’ll be your own fault.
Let’s face it, sometimes people don’t pay. It may be that they intended to pay, but mismanaged their own business to the point that they ran out of cash or are about to fold. Every once in a while, and in my experience this is VERY seldom, people request credit with the intention of not paying. There’s really very little you can do to prevent the occasional bad debt loss. It’s a cost of doing business and should be included in your yearly budget.
However, systemic bad debt loss can be prevented if you properly manage your credit policies. And the first place to start is by actually having a credit policy. Determine under what circumstances you will offer credit and the kind of information needed to establish a credit account. This really isn’t that difficult. Look around at other businesses in your industry or related industries and see what kind of credit policies they have in place. At a minimum, require a credit application with detailed information about the business and owner. If you don’t typically use purchase orders in your business, you should also include a promise to pay. This section should include any and all purchases and require the signature of an officer of the customer company. If you utilize purchase orders, you can skip this step. Some companies try to sneak a personal guaranty statement into their promise to pay. I find that this generally prevents getting a signature on the application needlessly and doesn’t really grant you much protection in the form you are seeking anyway. If you need a personal guaranty to sell the account, create a separate legal document for that purpose. And remember, in most states, getting the signature of only one spouse is practically worthless.
After you collect the information from the customer, look at it. It sounds simple enough, but many companies and credit personnel think that the process is about getting the application signed and a file created. And while that’s a great start, it’s just a start. Check the references from their other trade vendors and analyze the information. If the prospective customer pays their other trade vendors in a timely fashion, they’ll probably pay you on time. Don’t think that they will treat you differently though.
Based on the information contained in the application and from credit references, establish a credit limit that reasonably meets the needs of your customer. My approach has always been to try to meet the needs of your customer. If they are requesting a $10,000 credit line, analyze the information in terms of justifying that amount. If you are comfortable with that request based on their information, then grant the request. Send the customer, in written or electronic form, a summary of their credit line and your requirements for payment.
Before ever selling the first item on credit, make sure the customers understands your payment terms. You’re selling valuable products and services at a fair price. They should expect to pay you on time. Don’t be afraid to tell them that you expect timely payment. Start doing business with the expectation that they will pay on time and that they should not expect to get additional products and services if their account is over limit or late.
After the first sale, call the customer and confirm that the order was received and copies of all paperwork are in order. You should reiterate that you appreciate their business and that you’ll call again right before payment is expected to make sure everything is on track for timely payment on their account. Then, right before payment is expected, call the customer again and actually confirm that everything is on track for payment. Create the expectation that you will be paid on time. Follow-up with the first few orders to insure that a new customer is happy with your service, receiving their paperwork and that payment will be timely.
Training your customers to pay you on time is half the battle in accounts receivable collections. Helping them keep their account in order and payment on time is actually a valuable service to them and helps you generate more sales. If you have to put their account on hold for late payment, they can’t buy additional products and services and tends to create hostility. You can prevent this by properly managing the account and keeping it in order from the start. At the first signs of problems, talk with the customer and help them through their issues. Letting their account get into bad shape only creates a bigger problem in the future.