Business Credit: How to Keep Payments Coming During Tough Times
Businesses that sell products or services to other businesses and regularly grant them credit can avoid most bad debt by watching their customers for red flags and taking proactive steps to manage the credit they grant.
Granting credit to customers puts businesses in a position similar to a bank. Businesses want to sell to their customers, which requires them to extend credit in many cases, yet they must manage their customers' credit use to ensure they get paid for what they sell.
Writing off bad debts is expensive. For example, a business that operates on a 5 percent net profit margin must generate an additional $20,000 in new revenue to pay for $1,000 in bad customer debt.
Business owners should be intimately involved in making, monitoring, and reviewing credit decisions. In larger businesses, someone in senior management, such as the chief financial officer, should work with the credit manager on a daily basis to provide management oversight of credit.
Business owners and managers can use a number of strategies to spot bad credit trends and handle customers who appear to be having difficult times. Follow these guidelines to keep payments coming:
- Watch trends: Vigilantly watch payment history trends with customers as well as within your industry. Keep a close eye on customers who begin paying later than payment terms require. Businesses that rely on large publicly traded companies for substantial revenue should make it a practice to read their customers' quarterly 10Q reports. These comprehensive business performance reports required by the Securities and Exchange Commission are widely available on the Internet. You can get a feeling about the strength of publicly held companies by looking at their balance sheets, which is a part of the 10Q.
- Monitor credit reports: Businesses can access credit reports from Dun & Bradstreet and Experian Small Business Credit. D&B offers a monitoring service called DNBi that allows business owners to monitor credit on companies for a reasonable fee. Obtaining a credit report once provides a snapshot view of another business's credit, whereas credit monitoring allows you to access credit files of a particular customer anytime to monitor trends.
- Institute a soft collections program: Assign someone in your office to make collection calls every day. This person should be friendly and cheerful and know the fine art of talking to customers who owe money without offending them. Keeping lines of communication open with the customer is essential to collecting money owed and keeping the customer buying. When making collection calls, the collections clerk or manager should ask the other business for a promise-to-pay date. This is to keep any single customer from going very far past due and to limit the amount in the overdue column.
- Accept credit card payments as a collection tool: Good customers with business credit cards are often willing to pay their past-due balances using a credit card. You might also allow customers to purchase products or services with a credit card when they are on credit hold or cash on delivery. Credit card merchant programs charge a fee for the service, but the percentage is much smaller than the cost of a lost customer, a bad debt write-off, or lost sales.
- Convert an accounts receivable into a note receivable: As a last resort, you can agree to take all of a customer's past-due accounts receivable balances and convert them into a note receivable. Essentially the business credit grantor is accepting a promise to pay a percentage of the past-due balance each month while keeping the trade credit open. Use this approach only when the customer will likely overcome its financial difficulties and will be a good payer in the future. Use a promissory note to document the note receivable.
- Convert the customer to COD: Bankers have a saying: "The first loss is the least," meaning that when a customer gets so far behind in paying, the banker is less likely to lose money by cutting their losses than extending more credit. Business owners should use the same philosophy and carefully consider the chances that they may never get paid for a customer's outstanding balance. When customers fall into this category, the business granting credit should put the customer on COD. This way a sale is still made, but the risk to the business is fixed at what is currently owed in outstanding accounts receivable. One COD term should require the customer to sign a promissory note to pay off the old balance over time.
Sam Thacker is a partner in Austin, Texas-based Business Finance Solutions.
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