Giving Your Customers Credit: Do’s and Don’ts

In a nation that lives on credit, it can be a distinct advantage for a company to offer customers credit terms. Extending credit is a great way to earn customer loyalty. But it’s tricky territory because customers who need credit can also easily become customers who go bust and never pay their bills.

How do you know who should get credit terms and how much credit to give them? Follow these do’s and don’ts.

Do check references. Call your customers’ vendors and find out if they pay their bills on time. Also try to learn the terms of those bills; for instance, are they used to paying in 45 days or 60? This will give you a sense of whether they are accustomed to paying on terms promptly. Call several references to get a better picture of the customer’s payment history.

Do use a credit application. Require customers to fill out a form so you can verify all the facts.

Do get a credit report. This is easily obtained through Equifax, Experian, or TransUnion. The report will give you a credit score you can use as a benchmark of whether the customer is creditworthy as well as reveal previous bankruptcies, liens, judgments, and any accounts that are in collections due to nonpayment.

Do establish a credit policy. This defines the type of customer you will extend credit to and the circumstances under which you will lend. For instance, you might be willing to lend only to businesses that meet a certain minimum credit score or those that have been customers for more than a year. You might also agree to limit the credit you grant to a predetermined dollar amount, such as $5,000.

Maintaining a policy will help you weed out customers who aren’t creditworthy. If you have a credit-seeking customer who seems like an uncertain credit risk, it’ll be easier to say, “I’m sorry, it’s our policy that we only extend credit to companies that have been in business for at least five years,” rather than having to explain that you’re worried by their three previous bankruptcies.

Don’t extend too much credit. Be sure to analyze your own business cash flow and determine how much money you can loan for two or three months without negatively impacting your own operations. When you’ve extended credit lines in that amount, it’s time to close the program and stop taking credit applications.

Don’t extend credit informally. It’s easy to offer credit on the spot, as in, “It’s OK, you can pay me next week.” Don’t fall into this trap. With nothing in writing, it’ll be difficult to defend your rights if it comes to legal action. Once you’ve decided to extend credit, put your credit agreement in writing and define all the terms, including how much the customer can borrow at a time, the interest rate, the late fees, early payment discounts, and when the loan is due.

Do consider the company type. Keep in mind that if you extend credit to a corporation, the owners are not personally liable for the debt. If it’s a partnership or a sole proprietorship, they are personally liable.

One possible option is to ask the business owner to personally guarantee the loan if the company can’t pay. If the company sells merchandise, another option is to take a security interest in their goods as collateral against the loan.

Business reporter Carol Tice contributes to several national and regional business publications.