These five steps should be taken in sequence when establishing trade credit for new business accounts to minimize losses and create appropriate expectations with your customer.
Step 1: Get a Business Trade Credit Application from Your Customer
Every business that extends trade credit should get an application from the business it anticipates extending trade credit to. The application should indicate the legal name of the business and ownership; provide banking information and information on trade credit grantors. Often businesses will provide a preprinted “bank and trade references list to you, but the importance of your application is that the customer, by signing it, grants you permission to contact the customer’s bank and trade creditors for payment history. This application doesn’t need to be complicated, but in some industries (such as construction) it may be good to get a sample from an attorney specializing in the construction trade.
Several sources of free sample credit applications can be found online. Entrepreneur.com has a very simple business credit application in MS Word format that may work for many businesses. Microsoft offers a basic business credit template in Word format that covers all the bases too. You can customize either of them with your name, logo and standard terms of credit.
Step 2: Check Bank and Trade References
Having a business credit application doesn’t do your business much good if you don’t use it. Checking bank and trade references is a very common practice, and banks and other credit grantors have procedures for quickly returning the information to you. In the case of the business credit applicant’s bank, you should ask several questions usually on a form. First you want to know what the customer’s average cash balances are, when the banking relationship was first established, how many of the customer’s checks have been returned marked non-sufficient funds (NSF) during the last 12 months and if the customer’s borrower’s relationship with the bank is in good standing.
For trade references the important things to check are the date credit was originally granted, what the high credit has been over the course of the relationship, and how many times in the past 12 months the customer has paid beyond terms.
If you don’t anticipate granting a large credit limit to your customer and if you receive favorable information, you might skip step 3. The most ideal trade creditors to check are those that are similar suppliers to you.
Step 3: Check Business Credit Using Credit Bureaus
There are a number of commercial credit bureaus that you can use to check business credit. The two most often used are D&B and Experian Small Business. It might be a wise idea to set up a relationship with one or both of these credit bureaus depending on how many credit checks you are likely to order in a year. In both cases you can simply go to their Web sites and order several types of credit reports and pay on a per use basis. Don’t be bashful about asking these company’s customer service departments how to best use their reports in your business if you aren’t familiar with the report formats.
Step 4: Set a Credit Limit
After you have obtained a credit application, checked the customer’s bank and trade references and evaluated the business credit bureau report(s), it is time to set a credit limit. Part of this process should be anticipating how many dollars in goods and services are likely to be outstanding at any one time. Talking to the customer about his intended purchases is important in setting credit limits. In general, you don’t want to set your credit limit much higher than other similar trade vendors have set theirs. Setting credit limits takes practice to get comfortable with the process and starting low is a good strategy. If a customer hits a low credit limit, you always can evaluate their payment history and the specific circumstances of their needs. You can raise it temporarily or if you feel comfortable, on a longer term basis. It should be a routine practice to review all customers’ payment history and credit limits on at least an annual basis.
Step 5: Set Expectations with Your Customer
This step is important because you want your customer to know you know how to manage granting trade credit. Tell the customer right up front what their credit limit is and let them know you can review the limit when there is payment history to review and on special cases when the customer needs to exceed the limit on a temporary basis. This practice of talking to your customer about his payment history helps let the customer know you are professional. Make sure to thank customers several times a year when they have shown good payment history. If you start out with a small credit limit and feel comfortable raising it later, tell the customer you are raising it because you value their business and want to encourage them to buy more from you.
If your business uses these 5 steps to establishing trade credit for your customers your business will be using strong business practices that will help reduce your risk and as a bonus you are likely to do business with financially stronger customers.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions.
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