If you are selling on credit to your customers, they are treating you like a bank. They buy from you and end up paying months later. You are basically giving your customers free working capital. Payment terms are helping your sales, but what about your net earnings? Are you making any profit (and we are not talking about income statement profit here; we are talking about hard cash)? If your customers are treating you like a bank, you’d better be prepared to act like one. If you want to stay profitable while using payment terms, you must utilize tools that banks and other lenders use when extending credit.
Extending Payment Terms Without Breaking the Bank
1. TREAT NEW CUSTOMERS WITH CAUTION
Unless the customer is established, always start with Cash-on-Delivery (COD). Showing your generous side could actually end up hurting you. It makes sense to generate a track-record with a new customer before extending payment terms. If they try to push you on payment terms, tell them you will give plenty of credit after they establish a relationship. Starting with COD or a very low credit limit will keep your risk exposure in check while allowing you to get to know your customer.
2. COLLECT YOUR CUSTOMERS’ DATA WITH A STANDARD CREDIT APPLICATION
No matter what happens, have your customers fill out a trade credit application form. Getting as much information as possible will tremendously help you if that account starts going sour. Make your new customers fill out the application the first time they ask for payment terms. Tell your existing customers you are updating your credit files and ask them to send you their trade credit information. Putting together a credit application is simple; you can even use a credit terms generator to create your form.
3. DECIDING ON THE CREDIT LIMIT
Before you decide on how much credit to give your customer, make sure you do your due diligence. Check the trade references. Find out the range of trade terms your customer gets from other suppliers. The credit limit should be based on:
A) Your customer’s overall credit standing (You can check reports from Dun & Bradstreet, Experian or Equifax).
B) Your overall risk exposure. Always track your open positions and aged trial balances. If you have an accounting system, you can download it with a single click.
C) Your customer’s historical payment performance.
Resist the urge to extend payment terms more easily to existing customers just because they have been in business longer. Statistically, existing customers are just as likely to stop paying as new customers. If you do not have enough information on a particular person or business, you might be better off doing a search by using services such as Kroll. For big ticket sales that may have an impact on your risk exposure, it might be especially be worth the extra cost.
4. PERIODIC MONITORING
There are several red flags to watch for that could signify a customer going into delinquency. Specifically for customers that constitute a majority of your overall sales, monitoring their financial risk will help you make better credit decisions. Finding out about any liens, judgments, suits or UCC filings can save a lot of time and money during your receivables management process. It may be difficult to monitor your entire customer portfolio, but you should at least check your major accounts.
5. QUICK FOLLOW-UP AND A SOLID CREDIT POLICY
It’s a lot easier to set expectations with new customers than with old ones. So, the earlier you put a credit policy in place, the easier it will be to manage receivables. Your policy does not need to be complicated or harsh, but it needs to be clearly defined. For example, let your customers know what your net terms are, what kind of late penalty you charge and when you will contact them about late accounts. Then stick to your word. Whenever someone is late, resist the urge to give them a rain check. Follow your standard procedure. Clear communication is a critical component of receivables management. Make sure you quickly follow-up on your late accounts. Your customers should know that you monitor your books closely. If your customers think they are flying under the radar, they will gladly keep stretching their payments.
Never forget: by extending payment terms you are acting like a lender. If you can get paid in a shorter period of time, you can extend more credit (which gives you the power to sell more). Unless you put these practices into place, it will always be difficult to increase your ability to extend payment terms without increasing your risk.