The Dos and Don’ts of Extending Credit to Customers

As business owners, we strive to make it as easy as possible for our customers to purchase our products or services. Most of us accept credit cards and many of us also extend credit terms as a way to increase sales and build loyalty.

It’s the largest use of capital from business to business and remains the number-one alternative to personal and small business loans. In fact, the Small Business Administration reports that business extension of credit is the single-largest source of small business lending in the United States today.

While extending a credit term by as little as 30 or 60 days is just like offering an unsecured loan, it’s a risk most of us are willing to take. We’re simply providing goods or services in return for a promise to pay.

But as many business owners have learned during these tough economic times, promises are easily broken. So before you decide to extend credit to your customers, review this checklist.

What You Should Do

• Do establish a credit policy that will determine who you’ll extend credit to, how much credit you’ll extend, and how you’ll monitor that credit once it’s been extended.
• Do develop a thorough that includes trade references, banking information, credit-check authorization, terms and conditions, and disclaimers.
• Do pull a consumer credit report from one of the major credit reporting agencies to determine the creditworthiness of your customer.
• Do exchange payment data with consumer and business credit bureaus so you can reduce customer late payments and defaults and improve collections.
• Do offer several options in your customer payment methods, such as online bill pay, payment by mail, and payment by phone.
• In addition, be sure to look at the amount of business a particular customer gives you. Offering a customer a credit limit because it brings in a lot of revenue for your business is a smart move. If it also has a long history of supporting your business, then that customer will be more likely to pay its invoices.

What You Shouldn’t Do

• Don’t extend credit without putting your credit terms in writing.
• Don’t extend credit if your business doesn’t have significant cash flow.
• Don’t extend credit until you become fully aware of the laws governing consumer credit.
• Don’t extend credit limits that are greater than the risk your business can afford to take.
• Don’t extend credit to every customer that your business acquires.
• Don’t extend credit unless you have a collection policy in place that can manage and protect your accounts receivable.

The success of any business largely depends on the acquisition of customers. Once you’ve been established long enough to generate solid cash flow, you can begin to extend credit to some customers.

While cash is king, providing credit as an option can benefit your business in several ways, including greater customer loyalty and sales that may increase by as much as 50 percent. Before you make a decision, you may also want to consider asking customers for additional requirements, such as down payments and personal guarantees.

And remember: Despite the risks involved, the benefits of extending credit far outweigh the disadvantages.