Should Your Business Extend Credit?

It’s a growing small business dilemma: Do you need to offer your customers credit? If you sell to consumers, you can offer layaway plans and other simple methods for patrons to pay for their purchases before they receive them. You’re not expected to offer credit other than processing standard credit cards. But the situation is more complex when you’re selling to businesses, since standard business-to-business credit terms are Net 30, meaning the balance is due by the customer 30 days after the date on the invoice.

First, you must decide how much cash your business can tie up by offering credit. When your customers have not paid for their merchandise even while you must pay your vendors for products, your cash flow is reduced by the amount of money you have extended to customers as credit.

Clever customers, who are cash short, will maximize Net 30 terms. They’ll stock up early in the month, knowing you won’t invoice until the beginning of the next month and their payment will be due 30 days later. Effectively, your customers get 60 days of credit while paying Net 30 terms. However, as the business owner, your cash is tied-up for 60 days.

If you don’t have sufficient cash to offer credit and remain profitable, this could be the right time for this limitation: Don't extend terms, but provide financing alternatives. You can tell customers, “Due to the downturn in the economy, I’m not able to extend terms to anyone.” Instead, accept a wide range of credit cards: VISA, MasterCard, Discover, and American Express. In some cases, with larger ticket items – office equipment and furniture, as examples – a layaway plan might be appropriate. Customers understand that business owners are providing goods and services while working to stay afloat financially. Any creative financing approach that works for your customers will probably be welcome today.

If your business has sufficient cash flow to provide credit, remember you’re opening commercial accounts. Learn the commercial credit laws of your state. Start with the website of your state’s Secretary of State and your small business accountant.

Don’t offer "instant approval." You are about to trust your customers with your money. Develop a credit application form that is easy for your customers to fill out and provides what you need to process it.

• What is their business structure? Corporation, LLC, partnership, sole proprietor. When a business is not incorporated, you need the personal guarantee of the owner on any account because the company is not a legal entity able to enter into a contract.
• How long has the business has been operating?
• Get both home and business addresses and phone numbers. So many businesses are home-based now that this should not concern you unless it doesn’t make since for some reason. I recently noticed a large custom furniture-building facility with the name of the business on an attractive sign, located behind an elegant home in an area where you wouldn’t expect to see a barn-like manufacturing facility. If something seems peculiar, ask. Usually, there’s a simple explanation.
• Ask for their EIN (employer identification number) and their DUNS (Dun & Bradstreet Universal Numbering System) numbers.
• Have them provide three local trade references. Consider the references provided. If a painting contractor doesn’t list a source of paint or a mechanic doesn’t list a parts supplier, you might want to call the usual wholesalers for the appropriate goods in your area and ask if they’ve done business with your applicant.
• You want the name, branch, and business bank account numbers.

When you check trade references, ask these questions:

• When was the account opened?
• What is the highest amount of credit extended?
• Is there any history of late payments?
• Is there anything unique about the account?
• Ask them to rate the account.

Ask their bank how long the account has been open; their average balance for the past six months; whether the balance has stayed about the same month over month; account highs; and any credit history associated with the account.

In addition, become a merchant member of Dun & Bradstreet or Experian so you can access a copy of the commercial credit report one of these firms has compiled on your applicants.

Granting credit at any time is a risk. Granting credit during an ongoing economic downturn requires vigilance to ensure customers are worthy of your trust as a credit provider. Stephen Elias, an attorney who writes for Nolo, lists these warning signs for a business in trouble: 

• Pattern of late payments
• Selling off assets
• Changes in company personnel
• Changes in payment practices
• Changes in buying patterns
• Doing business in an industry or region undergoing significant decline.

While extending credit carries risk, I’ve known business owners who never had a loss. They claim it’s because of thorough analysis before granting credit and they stay on top of late accounts in nice ways to provide immediate alternative payment options. You can minimize your risks and maximize your return of money and happy customers.