Overview 

Even given the risks involved, sometimes it’s desirable to extend credit to your prospects and customers. Doing so can open up opportunities for increased sales at higher profit margins than would otherwise be attainable. In addition, depending on the nature of your business (e.g. consultants, contractors and other professional service providers), extending payment terms may be the norm. 

But although it may seem the practical thing to do, extending credit to your customers can be risky business. Thoughtful planning and careful consideration of requests for you to extend credit will help you avoid the crippling effects excessive bad debt can have on your business. 

Bad debt is a double whammy on your business: 

• It has an adverse effect on your cash flow; and
• It diverts your attention away from selling your products or services, requiring instead that you pursue your debtors for payment.

With the increased availability of credit, many people and businesses are finding it easy to get in over their heads. In fact, small business debt in some industries can be as high as 70% of net worth. 

In a perfect world, the cost of bad debt should not be a significant amount in your budget. The American Collector’s Association says uncollectable debt should be 5% or less of your gross profits. 

There are some steps you can take to minimize your losses and speed up your receipt of payment: 

• Establish a uniform credit policy for your business;
• Clearly communicate the policy to your employees and customers;
• Determine or verify your prospects’ and customers’ credit worthiness;
• Extend credit wisely;
• Use contracts where appropriate to spell out and communicate payment terms;
• Invoice promptly and regularly, with each invoice providing all information necessary for your customer to pay on time;
• Monitor your receivables closely; and
• Promptly collect overdue bills. 

Your Credit Policy

In creating your credit policy you should consider and state in detail: 

• To whom you’ll offer credit terms;
• How you’ll determine and verify credit worthiness;
• The maximum amount of credit you’ll offer and conditions under which that amount may be reduced on a customer-by-customer basis;
• The terms of the credit offered including payment terms and any incentives for early payment;
• The actions you’ll take if payments are past due; and
• How you’ll handle cancellations and refunds. 

Of course, if there are any other stipulations that meet your particular requirements, you should state those, too. 

Verifying Credit Worthiness 

There are a number of means to determine the credit worthiness of individuals and businesses. Typically, and with their permission, individual credit reports can be obtained from any of the three major credit reporting agencies: Experian, Equifax and TransUnion. 

Sometimes you’ll also want to get a credit report from one of those agencies for the principal or owner of a business. This is particularly true if the business is new or has not yet established a credit history as its own entity. 

For businesses, credit reporting can be found at Dun and Bradstreet, which maintains a database of some 13 million businesses. You may also find it useful to perform reference checks on businesses that request payment terms. This will take a little longer and will involve writing to or telephoning references provided by the customer. Those references should include a bank and two or three creditors such as suppliers. Ask questions regarding: 

• The length of their business relationship with the customer;
• The largest amount the customer has owed them; and
• The customer’s payment history. 

Don’t be surprised to get good references. You wouldn’t expect the customer to supply bad references, but make the requests anyway. You just never know what you’ll find. 

You’ll serve your purpose well if you stick to the standards you have set for credit worthiness. You’ll be better off declining the occasional sale than getting buried in bad debt. And you may find that if the customer is really committed to doing business with you, they’ll find another way to pay for your goods or services. 

Collecting overdue bills 

You’ll increase your chances of getting paid an overdue bill if you act quickly and decisively, following the steps you created in your credit policy. Document your actions to aid in communicating with your customers and to support your claim in the event you find it necessary to hire a third party collector or file a lawsuit. 

During this process it’s important to maintain, as well as possible, the relationship you have with your customer. You’ve worked hard to establish and nurture that relationship and it’s in your mutual best interest to keep it alive. Under the circumstances that may be difficult. 

For these reasons, communicating your credit policy to your customers up front, and then adhering to it, is of critical importance. Keeping the lines of communication open during the collections process is also desirable. After all, this delinquent customer may have been an excellent customer in the past and is just now experiencing temporary financial difficulty. 

As part of your credit policy you should create a collections policy that gradually ramps up your collections efforts over a relatively short period of time. The collections policy is essentially a time line with triggers for certain collections actions along the way. An example might be: 

• Send a friendly reminder by mail or email at the payment due date;
• Send a firm letter two weeks post due date; enclose a self addressed envelope to make it as easy as possible for the customer to respond;
• Telephone the customer three weeks post due date; try to determine the reason for the delinquency and, if appropriate, make payment arrangements or some other agreement for the customer to remit payment;
• Mail a collections notice five weeks post due date; keep it short and to the point and document it;
• Refer the debt to a third party debt collector seven weeks post due date. 

The progression through each of these steps, of course, is contingent on a lack of response or compliance by the delinquent customer. This collections policy, or one similar to it that you create, should be designed and implemented in a professional manner. 

It’s probably a good idea to have someone else in your organization, such as your bookkeeper, take the actions described in your collections policy – especially if you are the person who has the relationship with the customer. By doing so you’ll remove yourself from the nitty-gritty of the situation and leave yourself in a better position to maintain good relations with the customer. You’ll also free up your time to run your business and to pursue sales and customer service activities elsewhere. 

With some thoughtful planning and proactive accounts receivable management you can minimize the risks of extending terms to your prospects and customers. Offering this calculated flexibility will help you increase your sales, your profits and your customer loyalty. 

Ó 2005 Patrick A. Hassett. All rights reserved. 

Pat Hassett draws on more than 30 years experience in sales, sales management and sales support roles across several industries. He stands ready to help you increase your sales, your profitability and your customer loyalty through the use of customer-centric sales methods, high level customer service and customer relationship management tools. To learn more about how SalesNow! can help you, go to www.salesnowonline.com or write to infalesNowOnline.com. 

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