How to Handle Customers with Bad Credit

Credit risk is a part of doing business for most companies. That’s because in many industries customers expect to be granted payment terms. Or, in other words, the leeway to pay for goods and services at some point after delivery (usually 15, 30, or 60 days later).

It may be expected, but granting such terms exposes your business to the risk that you won’t be paid at all. Most companies simply have to live with this risk and, if they do get stiffed, write it off as a cost of doing business. But there are things you can do to reduce your exposure to high-risk customers with poor credit and minimize bad-debt losses.

The first step is to establish a formal credit policy that details the specific conditions under which you will grant payment terms to customers. Your policy should state your credit-evaluation criteria, how much credit you will extend, your payment terms (e.g., net 30 days), and penalties or interest that will accrue on late payments.

Create a credit application for customers to complete before you grant them credit. It should ask for references from other creditors, among other things. Be sure to contact these references and ask in detail about the customer’s payment history. For example, if payments were late, how late were they? And did the customer communicate openly and try to arrange a payment plan?

Ask for the customer’s bank account information and verify it with the financial institution. Ask about any credit arrangements the customer may have with other suppliers, since these might affect its ability to pay you. For a small fee, you can also run a Dun & Bradstreet credit check on the customer. This can be money well spent if it helps uncover a bad credit risk.

These steps will help you avoid granting credit to high-risk customers in the first place. But what can you do about late-paying customers to whom you have already granted credit?

Experts say the most important step is to act quickly. The likelihood of collecting an invoice drops from more than 90 percent after 30 days to just 74 percent after 90 days. So if payment was due in 30 days and you haven’t received it on day 31, make a courtesy call to the customer immediately to inquire about payment.

Depending on the customer’s response, you might consider negotiating a payment plan. It should specify that consecutive payments of a certain amount will be made over a certain number of months, with the invoice fully paid within six months. Be sure to put the agreement in writing and have the customer sign it. Also, make future delivery of products or services strictly on a cash on delivery basis until the account is paid in full and you’re sure that the customer is creditworthy.

If neither a courtesy call nor the offer of a payment plan gets any response, the next step should be to send a past-due notice, along with a letter explaining the delinquent status of the account. Experts vary in their recommendations on how often dunning letters should be sent and how firm the language should be, so use your best judgment, based on your knowledge of the situation and the customer and how much money is owed.

If the customer is still silent after 90 days, a final notice should be sent, informing the customer that the account will be turned over to a collection agency if payment is not received within seven days.

Such a threat should not be taken lightly. You must weigh the potential repercussions, such as a damaged relationship and perhaps loss of the customer’s business, against the cost of writing off the debt. And you must be willing to follow through and actually turn the debt over to a collection professional.