Extending Credit Strategies: The 5 “Cs” of Credit
Extending credit to a customer is about taking on a certain level of risk. There is no secret formula or mathematical equation that ensures you’re making the right decision. But by applying the 5 Cs of Credit, you can at least, make an informed one.
Number One: Character
What do you know about the customer? Has he exhibited integrity in former business dealings? Does he keep his word? One way to handle those of questionable integrity is to get references. What are other business contacts saying about him? The important thing is, a person can have the ability to pay, but if they don’t keep their word or are in some way untrustworthy, they are a risk you don’t want to take. It’s obvious that those who betray trust aren’t good candidates for extended credit.
Number Two: Collateral
By taking a lien, you’re staking a claim to your customer’s assets. In that case, you become their secured creditor. It goes without saying that you don’t want to go back and re-claim products you’ve sold to your customer in the event that he doesn’t pay his invoices. But by using a security agreement and financial statement, that’s exactly what you can do.
Number Three: Capacity
Capacity is all about cash flow. Most businesses experience the ebbs and flows of cash flow right along with the nation’s economic health (or lack thereof). Even the most responsible and conscientious customer can experience a turn of events that throws a kink in the works. But the bottom line is, can your customer still pay you even when there’s a temporary hitch in his cash flow?
Number Four: Capital
What’s your customer’s net worth? By comparing several financial statements, you’ll be able to see any trends upward or downward. If net worth is increasing each year, then capital is being put into the company.
Number Five: Conditions
The economy and market conditions play a role in everything across the board in business. For certain customers, tough economic times can be particularly challenging. When conditions are good, orders come in and the money flows. When they’re not, well … they’re not and your customer may react to it by letting some bills slide. When that happens, it’s time to tighten up your policies.
To determine which of your customers is the bigger risk to you, start by taking into consideration the Five C’s of Credit. It’s a great beginning point before you make any credit decisions.