Extending credit to business customers can be an effective way to build goodwill and nurture long-term buyers. But if you extend customer credit, it also brings sizable financial risk to your business, as cash flow could grind to a halt if these customers don’t make their payments. Even worse for the credit risk, they could declare small business bankruptcy and bow out of their obligations entirely.
For this reason, it’s critical to thoroughly research a customer’s creditworthiness before you offer any arrangement. Here are some ways to do so:
When dealing with vendors and other businesses, trade references are key. As you’re likely aware, these are sources that can describe past payment experiences between a business and a vendor (or other credit users).
Contact the potential customer’s trade references to check the length of time the parties have been working together, the approximate size of the potential customer’s account and its payment record. Of course, a history of late payments is a red flag.
Similarly, you’ll want to follow up on the company’s bank references to determine the balances in its checking and savings accounts, as well as the amount available on its line of credit. Equally important, determine whether the business has violated any of its loan covenants. If so, the bank could withdraw its credit, making it difficult for the company to pay its bills.
You may want to order a credit report on the business from one of the credit rating agencies, such as Dun & Bradstreet or Experian. Among other information, the reports describe the business’s payment history and tell whether it has filed for bankruptcy or had a lien or judgment against it.
Most credit reports can be had for a nominal amount these days. The more expensive reports, not surprisingly, contain more information. The higher price tag also may allow access to updated information on a company over an extended period.
After you’ve completed your financial analysis, find out what others are saying — especially if the potential customer could make up a significant portion of your sales. Search for articles in traditional media outlets such as newspapers, magazines and trade publications. Look for anything that may raise concerns, such as stories about lawsuits or plans to shut down a division.
You can also turn to social media and look at the business’s various accounts to see its public “face”. Plus, you can read reviews of the business. See what customers are saying and how the company handles inevitable criticisms. Obviously, social media shouldn’t be used as a definitive source for information, but you might find some useful insights.
Yes, assessing a potential customer’s ability to pay its bills requires some work up front. But, making an informative credit decision is one key to running a successful company. Our accounting firm can help you with this or other financially critical business practices.