Are Your Customers Creditworthy?

You can’t simply establish a customer’s creditworthiness at the beginning of the relationship and then assume everyone will live happily ever after. Even your best customers, the ones that always pay on time, can suddenly become your worst nightmare if they suffer a financial setback. You never want to be the last to know that a customer has hit hard times and is likely to leave you hanging.

If you extend credit to other businesses, now is the time to review your credit policies and make sure they’re functioning at top efficiency.

Run Regular Checks

You should run regular credit checks on customers that represent anything over 5 percent or 10 percent of your total sales. How do you do that? The two main credit-reporting agencies are Dun & Bradstreet and Experian. The price of a credit check can range from $40 for a one-page entry-level report to $1,500 for an in-depth, continuously updated filing that reveals the customer’s historical payment data, bankruptcy records, lawsuits and liens, and even predicts the likelihood that your customer will honor debts.

If you’re extending a large amount of credit to a particular customer, an up-to-date credit report may be a small price to pay for financial security. If the cost of credit checks is an issue, use the 80/20 rule: Identify the 20 percent of your accounts that represent 80 percent of your business. Then run regular checks on those customers.

Be Wary of Leftovers

These days, a lot of businesses are living on the edge and bankruptcies are approaching record levels. So you should be cautious of a new customer that once did business with your competitors but now wants to do business with you. Why? Because it’s possible this customer has been cut off by the competition and is looking for a new supplier that will extend credit.

The quickest way to check creditworthiness is to call up a few trade references and ask if the new customer has a track record of paying in a timely manner. The rule of thumb is to call two or three references. But if you’re the least bit suspicious, you should call five references or more. Potential customers may be able to get two references to stretch the truth on their behalf, but it’s a lot harder to get five references to fudge.

Also keep the limit low when you first grant credit. Make the customer earn the privilege of more credit by paying promptly. This practice will limit your exposure and enable you to evaluate payment performance before the stakes rise and real damage can be done.

Don’t Let Small Problems Get Big

Take a close look at your books and zero in on customers that represent an inordinate portion of your total outstanding balances. These are the customers that require the most attention as you conduct a review of your client base. Once your review is complete, take action against any that are slow to pay. If your credit terms are 30 days, you need to take action with any sizable creditors who have not paid by day 40.

Don’t be afraid to cut off a customer or place the account on cash-on-delivery status if you’re concerned with the customer’s ability to pay. If you don’t want to alienate longstanding customers whose creditworthiness has turned dubious, lower their credit limit after they’ve paid off their outstanding balance.

Remember, granting credit to customers is the same as loaning them money. It’s a calculated risk. But you can minimize that risk by evaluating -- and reevaluating -- their creditworthiness.

Tom Stein has contributed to leading business and general interest publications including Wired Magazine, Business 2.0, Venture Capital Journal, and Tennis Magazine. Previously, he held staff-writer positions at the San Francisco Chronicle, Red Herring, and InformationWeek. He also was a senior editor at Success Magazine, where he covered some of the most unusual and utterly unique entrepreneurial companies in the world.