In my last post, I provided an overview of the credit extension process. Many of my clients have asked for further detail and guidance on evaluating the applicant and the final credit decision.
There are two basic principles that are critical to the extension of credit. They are the ability to repay a debt, and the intent to repay a debt. Your credit decision should be based on quantifying the applicant with respect to these two principles. If you can verify the intent and ability to repay the debt, the decision should be relatively easy. The credit investigation should quantify ability and intent.
1. How do you verify the applicant’s ability to repay a debt?
There are certain indicators that will help you in your credit decision. The main things that would let you know whether an applicant has the ability to repay debt include the applicant’s income and assets. If you are extending credit to a consumer you may want to verify their income by having them provide copies of pay checks and bank statements. When dealing in a corporate credit environment, financial statements should be enough to provide this information.
2. How do you verify the applicant’s intent to repay debt?
The main way to quantify an applicant’s intent to repay debt is to verify past behavior. The easiest way to do this is with a consumer is via a consumer credit report (the three major reporting agencies are Equifax, Experian, and TransUnion). In the corporate environment, the best way is to contact bank and trade references.
THE CREDIT APPLICATION (COMMERCIAL) –
The credit application is designed to gather information that will be verified and in turn used to assist in the decision process. An application should provide the following information:
Applicant Company Legal Entity Name (including any d/b/a’s)
EIN (Employer ID Number or Federal Tax Identification Number)
Principals’ Legal Names (and SSN / DOB’s / Addresses if requiring a personal guarantee)
Banking References including banker’s name and contact info
Trade References (at least 3)
CPA contact information
Amount of credit applied for
Place for applicant’s signature (Verify the individual signing has the authority to bind the company)
Any special terms requiring a “meeting of the minds” (i.e. finance charges, late fees, personal guarantee, authorization to pull credit on officers, etc.)
APPLICATION (VERIFICATION) PROCESSING –
Once the credit application is submitted, you should verify the information given.
CORPORATE IDENTITY: Most states’ Secretary of State websites will allow you to verify the corporate status. When you do this, print the information and keep it with the application (you want to set up and keep a credit file). Any discrepancies should be discussed with the applicant.
TELEPHONE: Dial the telephone number and see if they answer with the name given, or another name. Any discrepancies should be discussed with the applicant.
WEBSITE: Print the home page of the website and keep it in your credit file. Look for any information that may help you with your decision (press releases, news, info on suppliers/vendors, etc.). Any discrepancies should be discussed with the applicant.
EIN: There are sites to facilitate EIN verification. Any discrepancies should be discussed with the applicant.
PRINCIPALS: If you are requiring a personal guarantee you may want to verify the validity of the individual’s address. If the potential risk is large you may want to pull credit reports on the guarantors to get further insight into their intent and ability to pay their personal debts as this could become a personal debt if the company defaults.
BANKING REFERENCES: You may contact their bank and request a reference, but the bank may decline to give you any information. If this is the case you can ask your applicant to provide a recent bank statement.
TRADE REFERENCES: Most people only provide references they know will give a good reference. Still, you may be able to get some information that will be helpful. You want to know how long they have been doing business with your applicant, high credit amount, terms and payment history. If you look on your applicant’s website you may find other suppliers/vendors you might be able to get a more objective reference from.
CPA INFORMATION: You don’t need to contact the CPA during the processing period, but should the applicant go into default the CPA may be of value at that point.
Make sure you document all the information you garner during the credit investigation. Keep all the information in the file as you will need this in the event of default. Once you have completed the investigation you will need to determine the amount you are comfortable in extending to your new client. Any discrepancies need to be discussed and if you feel the explanations are insufficient you may want to reconsider extending terms to the applicant. The information in the application should be given freely. If the applicant is hesitant about providing information it could be indicative of a problem with their intent and/or ability to repay your company for goods or services provided on credit.
The credit application is a valuable tool in the event of default. Keep the application and all other information gained through the application process in the credit file for future reference. You may want to scan the documentation onto your hard drive as well.