Most, if not all, businesses grant credit terms to many customers and clients. However, the practice often welcomes new risk.

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The minute you grant credit you have introduced risk into your business through the possibility of not collecting all or any of the credit you have granted.

In fact, you have now become a banker; you are bankrolling some of your customer’s cash flow requirements and are hoping they will pay the entire amount upon agreed-to dates.

In the event they pay late, you will be chasing them and expending effort that you would prefer to focus on other parts of your business.

If you have to resort to the use of collection agencies and, ultimately, legal action, it means you will be losing some or all of the profit you made on the original sales transaction.

Even worse, depending on how the affair ends, you may lose more than the profit of the sale, you may lose the money you invested in the wages, raw materials and other expenses you incurred to deliver the product or service.

In fact, if you have to go to the legal route and end up with a dry judgment (meaning you win the case but can’t enforce the judgment because the other party has no cash or other assets), then you are losing even more than the profit because you will have to pay the legal, filing and court costs.

In essence, on a small scale, you are living the life of a banker. What should you do to protect yourself? It is important that your invoicing, contracts or other means of accomplishing a sales transaction involving the granting of credit comply with all applicable laws in the jurisdictions
that the transaction, and the players in the transaction, are considered to have nexus to.

The terms of credit outlining repayment terms, such as dates, amounts, the interest charged on overdue amounts, etc., must be clearly spelled out or else they may be unenforceable in a court of law.

All of the above deal with the middle of the credit granting infrastructure and administration in your business. Now let’s jump to the beginning of the process once all of the above items have been set up.

You are now playing banker. Learn from the pros and follow their “best practices” to the extent possible in determining who you will lend to. Don’t just lend to anyone.

You shouldn’t extend credit to someone else if you don’t have the cash or access to credit, to carry the amount of their receivable, in addition to all other items you need cash for.

If you have the capacity to lend, then you need to really understand your client/customer. Your lawyer will advise you as to the types of information that you can legally request from a prospective account to aid in your credit granting decision.

The information can be personal net worth statements, financial statements of a business, credit references from other vendors from whom the applicant receives credit. Once you have all the information, make sure you or someone who is proficient in evaluating it actually reviews it and follows up with the references.

Once the information is properly reviewed and understood the difficult decision of granting or rejecting credit must be made. If credit is granted then the setting of a credit limit needs to be done.

You might want to use your accountant to help. Also, it is usually advisable that you have individuals or private company clients sign personal guarantees or other documents acknowledging their indebtedness and the terms of the credit that they are accepting.

Monitor your clients’ accounts weekly; don’t let them get old, start internal collection efforts quickly, be firm with respect to stopping delivery of services or goods to clients whose credit limit has been reached or whose ageing of the account has hit a specific number of days even if
the dollar limit has not been reached.

Monitor not only your clients’ accounts with you, but also their business health and creditworthiness. Do this by making sure you have at least annual updates of all the info you asked for at the inception of the account.

Keep your ear to the ground for news on any developments, good or bad, affecting your clients. Speak with others in your industry to hear the buzz.

Go to your clients’ places of business and look around. How busy is their office, their shop, their manufacturing area, how many cars are in the parking lot? Speak with the owner or manager, develop a good relationship with their controller, accountant, bookkeeper, accounts payable clerk or other similar individuals.

If you depend on your bank line, every dollar you finance every day is costing you interest and eroding some small portion of your profit due to interest.

In some cases, the margining calculation on your receivables immediately disqualifies an entire account because a portion of it has exceeded 90 days. Watch your receivables like a hawk, just like the bankers watch you and your performance

Remember, if your gross margin is 50% and you write off $1 of receivable, you need to sell $2 to make it up. If your margin is 20% and you write off $1 you need to sell $5 to make it up.