Nearly every business provides credit in one way or another. Every time you sell goods or services and do not get immediate payment, you are effectively giving your customer a loan. And you may be giving them an interest-free loan. Providing credit in this way has a number of disadvantages:

• It alters your cashflow projections. You have paid your suppliers but you can’t recoup expenses until your customer pays you.

• You may need to employ people to keep track of credit accounts. If you are a small operator you may end up spending valuable time just keeping records.

• Assessing credit applicants can be time-consuming and costly.

• You run the risk of never getting paid and spending large amounts of money trying to recover debts from delinquents, cheats, and cash-strapped or bankrupt businesses.

On the other hand, most businesses provide some form of credit because it makes good business sense to do so:

• Businesses that offer credit generally outsell cash-only competitors. Customers have more incentive to buy when they can pay later.

• Extending credit helps you establish a trust relationship with a customer.

• You may gain valuable market information through credit applications.

• Credit tends to smooth out seasonal highs and lows in purchasing.

• Credit can be very appropriate to certain kinds of sales – such as those made over the phone.

Good credit management will enable you to use credit to your advantage while minimizing disadvantages.

You provide retail credit when customers pay by:

• installment account

• charge account

• cheque

• credit card

Installment accounts

Retailers often offer installment credit when they sell items such as cars, computers, televisions or other major appliances. They get a customer to sign a legally binding agreement to pay over a set period of time and at a specific rate of interest.

If you extend this kind of credit you need to make a judgment on the customer’s character and capacity to repay. You may also ask for collateral.

A detailed credit application form will help you decide if an individual is a good credit risk. You should do some homework to confirm the application details. Check employment details and talk to referees for example. You may be able to get a customer’s bank to provide you with a rough idea of their average bank balance. You can also use credit-reporting businesses to gain information on your customer’s credit history.

The downside to granting installment credit is that you may wait as long as three years to get full payment for your sale, while you have to pay your suppliers within a month. You also need to employ people to keep books, mail out letters, track payments, and take action to collect overdue amounts.

You can avoid this by selling your debt to a finance company. The finance company will offer you a discounted price for the debt, and at least you will have most of your money without having to worry about managing repayments.

Charge accounts

Retailers often allow customers to buy inexpensive goods on a charge account. They may charge no interest if full payment is received by the end of the month of purchase. This system is generally more suitable for larger retailers as keeping track of charge accounts can require a lot of administration. However, you may see the charge account as a useful incentive to your customers to buy.

Checks

A lot of bad checks are passed each year but if you use screening and take out insurance you can minimize the risk of getting burned.

If you decide to accept checks you might want to use a check verification service. These companies will verify a check over the phone on the basis of a driver’s license, state ID or military ID. Verification services generally provide a guarantee and many will also provide insurance. Their fee may be less than the merchant fee charged by credit card providers.

When you assess a check, make sure that it draws on a local bank, is dated accurately, and is under 30 days old. The written and numerical amounts should match.

A driver’s license is a useful form of identification because it is difficult to obtain and contains a signature and photograph. Check verification companies rely on the probability that if the signature, photograph, and details on a license match up with the person offering the check then the check is most probably okay.

Credit cards

Credit cards remove many of the downsides to providing credit. When your customer buys with a credit card, the card provider accepts most of the risk. You can be sure of getting your money within a short period of time. You don’t have to employ people to assess credit applicants or chase debtors for payment. Credit card companies will, however, expect you to stay up-to-date on lists of invalid credit cards. The card provider will charge you a fee, but you may build this into the cost of your goods.

Credit cards fall into two broad groups - bankcards and entertainment cards.

Bankcards include Visa and MasterCard. These companies offer clearinghouses for the card activities of the banks they work with. The cards don’t need to be paid off in full at the end of each month. The banks that supply the credit are happy to keep earning interest.

You give credit to other businesses for the same reason you give it to consumers - it promotes sales. But before you grant credit you need to assess a business and/or its owner. Be guided by these five criteria:

1. Character: Verify integrity and honesty. Assess companies by their business practices and ethical policies. Make sure individuals are responsible and reliable.

2. Capital: Check that a business has the capital to underwrite operations and has an appropriate level of cash and assets.

3. Capacity: Rate a business by its ability to conserve assets and stick to a financial plan.

4. Conditions: Consider other factors affecting debt payment. How may repayment be affected by a recession, natural or business disasters, competition, or labor difficulties?

5. Collateral: Can the borrower offer security to cover cashflow difficulties?

Have companies lodge a credit application that will give you enough information to assess their credit status. As with individuals, you also need to check their references, see how much information you can get from relevant banks, and use credit reference agencies to provide a credit history.

You might want to take out membership with a credit status agency as this may reduce your assessment costs. Or you can research credit history on a credit agency website.

Billing methods

Unless you operate on a cash-on-delivery basis your billing will probably involve either promises to pay or orders to pay.

Invoices and promissory notes are both classed as promises to pay. Every time you send an invoice, you are granting credit according to the invoice payment terms. If you are worried about creditworthiness you could ask for a promissory note which guarantees payment.

An order to pay is a document that contains details of the payment method and payment date. When the order is accepted it becomes a ‘trade acceptance’. You can then use it as a guaranteed source of receivables income.

Terms

You don’t want to give people access to your money for any longer than necessary, so you should be explicit in the terms you set. Spell out your terms in transaction documents.

While you may want to set conditions when you grant credit, you also want to get a good deal when you seek credit. Be tough when negotiating terms and make them clear on your documents.

For example, you can delay the start of the billing clock by accepting goods ‘ROG 25’. That is, you are assumed to receive goods at the end of the standard billing month, though you may have received them a couple of weeks earlier. Specifying these terms will prevent your supplier from starting the payment clock at the date you ordered goods.

Try to have goods delivered ‘FOB destination’. If goods are ‘free on board’ at destination, it means that the supplier covers the shipping costs.

Using other peoples’ money

As a rule, it is best to pay your bills when they fall due. This is especially important at the beginning of a relationship when you are trying to establish a credit history as a reliable business. If you are going to be late in paying keep your creditors informed so they don’t worry about payment problems. Be aware that payment problems eat into the goodwill you have with a creditor.

However, many businesses like to delay payment as long as they decently can. Some businesses have a policy of not paying an invoice until they receive a ‘past due’ reminder letter. This is a common strategy, especially during a recession or for companies that have cashflow problems.

It is worth bearing in mind that widespread use of slow payment can have an economy wide impact. If a large percentage of businesses stretch out their payment terms then cash flow distortions and unpredictability start to erode the business environment. For this reason, slow payers tend to look antisocial.

It would be financially desirable to collect 100 percent of your debts as they fall due. On the other hand, you might generate better customer relations if you show flexibility to your debtors. Bear these conflicting demands in mind when you seek payment.

If you are not sure how much leeway to give you can be guided by the standards of the industry you operate in. Businesses that sell highly perishable products tend to be strict in demanding payment. Sellers of durable goods can afford to show more latitude. Whatever policy you develop you need to communicate it to your employees so that you maintain a consistent approach.

Many payment problems can be avoided since a large proportion of late payments are due to invoicing flaws. Make sure invoices are accurate, clear, well formatted and printed, and that your invoicing procedure is efficiently organized.

The collection process

Overdue accounts use up your working capital, hinder further sales to a client, and expose you to bad debts. You can encourage payment by stepping through a series of requests for payment. How quickly you move through these steps depends on your payment policy. You need to judge your tone carefully because you do not want to jeopardized your customer relationship by being too aggressive.

1. Start with a friendly reminder that an account is overdue and perhaps include a copy of your first invoice.

2. If this does not work, send letters that request payment more firmly. You may want to send several of these, perhaps spaced out at ten-day intervals.

3. Make a demand for payment. Demand letters should be short, sharp, and to the point, so they won’t be set aside by mistake.

4. You may find that a phone call will sort things out if you are getting no satisfaction. When you ring, be cordial but firm. Try to find out what the payment problem is. Is the customer confused, careless, suffering short-term problems, or simply a poor payer?

5. Resolve any problems if you can and decide whether you can risk being flexible over repayment. Aim to end the phone call with the customer undertaking to make payment by a definite date.

6. If you still haven’t been paid, you can threaten legal action. The threat of involving a debt collection agency will often force payment as companies will want to protect their credit rating.

7. The last step is to hand the debt over to a collection agency or actually take legal action.

8. Collection agencies will generally handle debts over $50. Test a few agencies before settling on one. If you want to pursue collection yourself you can make a complaint to a small claims court. This will force a meeting between you and your debtor. Cases are usually resolved in favor of the creditor.

There is a lot of legislation on credit issues. You may want to speak to your lawyer about your credit management procedures and see if there are any issues you need to be aware of.

Aging accounts

You need to keep records so that you can track overdue payments. You may want to do this manually, perhaps by setting up a system of color-coded folders, and moving accounts from one to another. Each folder could trigger a different step in your collection process. Or you may decide to buy software that will automate the process. Whichever method you choose, you need to make sure you have good information on all money owing to you.

Be methodical

''If you owe the bank $100 that's your problem. If you owe the bank $100 million, that's the bank's problem.''

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