Extending credit inherently takes a large degree of trust, trust that may or may not be well founded. Credit has become such an ubiquitous part of the today’s business community that we sometimes forget the risk it actually entails. But what are we to do? Stop dealing in credit? We wouldn’t dare. Credit has enabled us to do some pretty incredible things, but that still doesn’t mean we shouldn’t proceed with caution. The trick is not to abandon credit altogether (as it’s what keeps your business competitive and your customers happy), but rather learn how to mitigate the risks involved. For this reason a credit report stands as a valuable asset, to both protect and safeguard your business from potential problems down the road. Taking the small steps early to screen through a customer credit check will save you a great deal of time and money.
How to Perform a Customer Credit Check
1) Get Permission - While we all wish we could be secret agents, sadly we cannot be so stealthy when it comes to credit checks—nor should we. In order to run a customer credit check, federal law mandates that you need the permission of the person you are running the report on. While federal and state governments do have ironclad rules governing people’s rights regarding credit checks, it is also in your best interest to observe them as well—even outside of all these legal ramifications. Obtaining credit reports shouldn’t be a secret affair, but as Ken Lin, CEO and founder of Credit Karma, says, it should be the beginning of a conversation. You can never know exactly what the context is concerning the credit history of your potential customers until you ask them first hand and give them a chance to respond. Regardless though, customer credit checks will give you a much better foothold on which to stand when deciding exactly who you should or shouldn’t extend credit to.
2) Head to the Credit Bureaus - Once you have all the necessary information, you can enlist a credit bureau (such as Dun & Bradstreet) to obtain the Credit History Report of the person or company you seek to do business with. The report will, thus, allow you to obtain information on your customer’s financial history, including in most cases a credit rating predicting the likelihood that the particular customer will pay on time. Depending on the credit report as well, you can also receive relevant legal information on past and ongoing lawsuits, claims and bankruptcy filings concerning the customer. This kind of customer credit check does not come without a cost and can actually be quite expensive—ranging from $15 to even $1000 per report.
3) Set a Standard - To avoid any unwanted biases that could get you into some trouble, you should set a standard credit score limit or baseline level up front, establishing a minimum score for your potential customers. As Lin states, “You should have a consistent threshold of what a good score is. You don’t want to be discriminatory of how you do it.” As humans we naturally let emotions into the mix, sometimes possibly causing us to extend credit to someone, regardless of all the red flags. To prevent this though, setting up discriminate concrete levels as to where to draw the line is a good way to weed out these sometimes uncontrollable instances where we extend credit to a bad bet.
4) Ask for References and Letters of Credit - Credit references stand as another solid point of comparison to the original report itself and can act as a further screen. References, though, at times must be taken with a grain of salt, especially if the customer or company supplies them. For this reason, it is always good to pin point your own leads during a customer credit check and find references for yourself, so as to get the true story—or at least part of it anyway. Hearing from companies’ past suppliers, customers or previous business partners is a the best form of a customer credit check. A Letter of Credit from the customer’s financial institution exists as another solid tool to determine past payment behavior and to determine whether you should or should not extend credit to someone.
5) Don’t Deny the Obvious - When debating extending credit to another business, sometimes the best indicators of credit can be resting right on the surface. As part of the customer credit check, ask relevant questions such as how long has this company been in business, what clients have they worked with, who are their customers, how has their relationships been handled in the past, etc., to get a better sense of the company’s past history. It’s a good sign if they have been in business for a very long time and appear to be pretty stable.
All these elements—from credit history reports, to references, to company histories—should not be viewed independently from the rest. In order to get the full picture of what is truly going on you must view all of them collectively as individual pieces to one giant puzzle. You should not simply pull one credit report and then call it a day. Being smart when it comes to a customer credit check relies on ones ability to view signs from a multitude of angles. Only that way can you truly mitigate the risks involved and maximize the potential of working with credit overall.
This post was written by Arie Hefter.