The biggest consideration when pondering extending credit to your customers is whether to predetermine creditworthiness or allow any client to defer payment. Each approach has benefits and nuances that must be explored.
Taking It on Faith
Smaller businesses often opt to allow their customers to do business on credit without running any sort of risk assessment beforehand. The main benefits of operating this way are:
- More access to credit means more consumers of your goods and services.
- Skipping suitability testing keeps your operation from getting bogged down.
- Extending credit to everyone helps to foster positive feelings about your business.
- Creating relationships through easy access to credit helps promote repeat patronage.
When you decide to forego upfront payment in favor of a system in which you bill clients after services are rendered, you create good will that could translate into future business and new contacts through word of mouth. However, you also expose yourself to the financial risks of not being paid in a timely manner—or at all.
You can minimize these risks by requiring first-time or one-time customers to pay before you transfer goods or provide a service, either in cash or with a credit card.
Looking for Skeletons in the Closet
The other approach to creating billing relationships with your clients is to set standards potential customers must meet in order to take advantage of credit terms with your business. You would then examine each candidate, only extending credit to those who meet your requirements. The benefits of this method are:
- Less financial risk because you’re offering deferred payment to clients with demonstrated abilities to pay and good track records.
- More reliable revenue stream.
- Better risk profile for your business because of decreased financial exposure, which could help you to secure investment and loans.
The downside is that you may miss out on customers who won’t be able to meet your standards. Many companies find the potential lost business is a small price to pay for the stability offered by pre-screening.
Collecting What You’re Owed
Whether you decide to assess creditworthiness beforehand, choosing to extend deferred-payment terms to your clients puts you on the hook for any revenue gaps. You will be responsible for collecting on delinquent accounts. How you do this depends on your company’s size and the resources available to you.
Smaller companies may have credit departments that amount to little more than the owner of the business and a few key staff members. Larger entities often have entire departments devoted to the extension and management of credit. These departments not only collect on past-due accounts, they also often handle candidate risk-assessment and make determinations on creditworthiness and terms.
Regardless of size, all companies that extend credit have to decide whether to collect the money they are owed or to simply write off their losses. If you choose to collect, it’s customary to do so in stages based on the time that has elapsed since a customer missed a required payment.
- 30 Days: Most businesses send a letter informing the delinquent client of failure to pay and advising him or her of potential penalties for continued non-payment. Larger companies often call clients if the amount owed is above a certain threshold.
- 60 Days: A more forceful demand letter is sent. Smaller companies typically make phone calls at this stage to seek promises of payment from late customers.
- 90 Days: A “final notice” letter will usually be sent to a late client specifying serious potential consequences for continued delinquency.
- 120 Days: Most companies “write off” late accounts at this point. This is usually when they are handed off to collection agencies or in-house collection specialists. Depending on the amount of money involved, varying degrees of legal action may be pursued.
The benefits of extending credit to your clients are clear, but so are the risks. Carefully consider whether your business goals would be best served by offering deferred payment to all, or by taking steps to prequalify customers first.
The content on our website is only meant to provide general information and is not legal advice. We make our best efforts to make sure the information is accurate, but we cannot guarantee it. Do not rely on the content as legal advice. For assistance with legal problems or for a legal inquiry please contact you attorney.