Extending credit to customers is a natural part of doing business, yet one of the big questions almost all businesses will face is who to grant credit to. No matter how diligent and proactive you are, there will always be those who do not follow through on their commitments, but here are three simple questions to ask yourself to help minimize the risk to your bottom line.
1. How big of a risk can I afford to take?
While there are certainly many factors that go into this decision, one major component to consider is your profit margin. The higher your profit margin, the more risk you may be able to comfortably take on because you are making more profit with each sale. Other factors to consider are: the health of the business, future sales prospects, and how comfortable you are with the possibility of a customer not paying. You should also always consider how important the client is to your company and whether you can afford to lose them.
2. What do I know about this customer?
This is where the 5 C’s of credit come into play. Before extending credit to any customer, you should always answer these questions about your customer. Morally speaking, does this customer have the Character of someone who will pay what they owe? Do they have the Capacity to pay? Does the customer have financial strength, as determined by their Capital (net worth or equity)? Does the customer have enough Collateral, in the form of equipment, property, or other resources, to cover any unpaid debt? Finally, you should always look forward and asses the future Conditions of the economy as they relate to the customer’s business.
3. What will the terms be?
Though this may seem obvious, it is always important to take a step back and really think about the terms of the agreement. Do they mitigate risk as best as they can? Are they in the best interest of your company? It is also important consider how long to give the customer to pay their open invoices. In many cases, business operate on net 30 terms which means customers have 30 days to pay their open accounts, but in some cases a greater sense of urgency can help. You should consider whether operating on net 15 or 20 might serve your business better by imposing a greater sense of urgency without offending your customers. There are many arrangements that can work, but it is important to find the system that best fits your business needs.
This is by no means an exhaustive list, nor should these be the only questions you ask before extending credit to any customer, but answering these will force you to take a step back and mitigate the risk of making costly mistakes. It is always important to step back and examine the bigger picture. If you are interested in learning more about proper and safe ways to extend credit, please click on the link below to read our FREE ebook on “How to Extend Business Credit”