Businesses today must be willing to grant credit. To be successful you must know how to:
- extend credit wisely
- monitor accounts efficiently
- collect receivables effectively
Both the seller and the buyer share advantages and disadvantages in doing business on credit. The main benefit to the seller is that it can increase sales. People who could not normally buy from you due to lack of ready cash are now potential customers.
One disadvantage of a credit transaction for the seller is the additional cost. When you sell on credit it means that you do not receive cash immediately but you must still pay your operating expenses. This usually results in a greater demand for working capital, maybe even borrowed at the current interest rates.
You must also add the costs of determining the customers payment ability, maintaining additional records, sending and collection of bills, and the inevitable bad debts.
SETTING CREDIT POLICY
If you decide to offer credit you must establish a credit policy that will protect you and your business in as much as you can.
Operating a retail business that grants credit is a relatively simple operation. Arrange to accept one or more major credit cards to ensure that many of your customers will have credit available to them, with little risk to your business.
If your business operates at a wholesale level or you are not able to accept credit cards you will need make a decision regarding credit terms and conditions.
These decisions will include:
- how long your customers will have to pay, 15 days, 30 days, 45 days
- whether discounts will be available for prompt payment
- if interest will be charged and when
- what procedures to follow when accounts become overdue
Granting credit is the evaluation of each customer according to the three C's of credit:
- Character, the intention and willingness to pay
- Capability, the ability of the individual or business to carry the proposed debt
- Capacity, the ability to handle the proposed repayment schedule
CREDIT INFORMATION
For the collection of credit information an application form is required. You can use a purchased form from an office supply store or design one yourself. Credit information you should collect:
- name (both personal and business)
- address (both personal and business)
- length of time, at the residence location as well as business location
- bank references
- trade references
- financial obligations
The information must then be verified.
Verify information by:
- telephoning the applicant's bank
- calling trade references
- calling other suppliers
- checking with the local credit bureau
- calling the Better Business Bureau
- obtaining a report from Dun & Bradstreet or another agency
If you accept a credit application be sure to explain your terms clearly to your customer. Misunderstandings are far better handled before the order is delivered not when the account is in arrears.
RECEIVABLES TRACKING
While it is important your credit policy is fair, a consistent collection policy is essential to making the credit system work. Establish a policy that is firm and fair; stick to it even at the risk of losing a customer. If a customer has an overdue account and it is difficult to collect now it will only get worse as time passes. A customer whose account is always paid up is more likely to return to your business more so than one whose account is always in arrears.
Granting credit means accepting risk but these risks can be minimized by establishing and then following proven collection policies and procedures right from the start.
