Managing Customer Credit

By Larry Chester, President

There is probably nothing more painful than determining the credit limit for a new client. Sales wants the deal almost no matter what, while Accounting wants to make sure that it can collect.

Those counterbalancing forces are always at work. Companies need to put a procedure in place to make sure that someone is watching the store.

Let’s be serious for a minute here. Credit policy is not a simple matter and shouldn’t be taken lightly. Not having a credit policy is a little like signing a bunch of checks and leaving them on your receptionist’s desk for anyone to take. That sounds silly, but there’s a definite reality here.

When you sell something to a new customer, and they don’t pay you, that’s exactly what you did. I’ve often told my salespeople that a sale isn’t a sale till the invoice is paid. If the invoice doesn’t get paid, then you just sent a gift out to your customer.

So how do you protect yourself? There are really two aspects to this:

1. Establish a credit policy that’s reasonable and easily manageable.
2. Revisit not only the policy regularly, but also each customer’s credit worthiness.

Establish a Credit Policy

It’s important to remember that not only does the credit policy need to be strict enough to improve the chances that you’re going to get paid, but it can’t be so strict that it keeps customers from buying from you.

Here are some simple ways that you can establish a solid policy.

1. If you subscribe to a credit monitoring service, look up their credit rating.
2. Get three credit references and CALL THEM. You might think that the customer will only give you the names of companies that they pay on time, but surprisingly enough, you can find out important information by asking simple questions. When you call the reference, ask:

• How much credit they are granting to the company?
• Have you recently changed your credit terms with the company?
• What payment terms did they grant?
• Is the company paying their bills on time?
• How long have they been providing credit?
• Has their payment performance changed since terms were provided?

3. Talk to their bank, with the permission of the customer, and find out what their average balance is in their operating account, and how much of their credit line they’re using. You won’t get specific numbers, but they may tell you “mid five figures” which tells you something that you didn’t know before.
4. If they’re pushing you to increase the amount of the credit you’re granting them and you’re concerned, ask for a deposit on the order. Doing that minimizes your risk and allows the new customer to build credit with you.

Do you follow-up?

One thing that I’ve found over time — both as a CFO, and as a company granting credit — is that once credit terms are established, they are rarely if ever revisited. I understand the reason why.

Doing the research that you need to do to establish credit for a new customer is a real pain. And the more customers you have, the more work it is to cycle through all of them to review their credit. When would you do all that work? You already went through it once, why do you have to do it again?

There’s a good reason why. Look at the economic conditions the country and the world are in. We have gotten past the pandemic, and everything is mostly back to normal, right? It isn’t.

The economy is living on the edge. The near-term forecast is for interest rates to continue to rise. Even though some companies have laid off staff, there is still a staff shortage. Salaries are up, and benefits are climbing to make hiring more attractive. Banks are busy re-evaluating their loan portfolios. There’s a lot of money in private equity, but the business loan market has tightened up.

Companies that may have been strong before the pandemic might now not be. But that’s the point, isn’t it?

Just as things have changed for your company, things have likely changed for everyone else as well. You don’t know if your customers are among the companies that got a windfall from the pandemic or struggled to make it through. You can’t sit idly by and assume that everyone that you’re doing business with is in just as good shape as they were pre-pandemic.

The only way to know for sure is to do another credit check. It’s not unreasonable, especially considering the turmoil the economy has been in lately.

Business changes. Some large companies insist on getting regular financials from their major suppliers, just as banks demand monthly financial reporting. They depend on the financial stability of their suppliers, just as banks depend on the financial stability of their customers. Privately held companies are uneasy about providing financial information to their suppliers. But remember that it’s your money, and it’s at risk if you don’t assure that your customers are able to pay you.

You need to protect your company against the changes in the financial fortunes of your customers. Obviously, your customers aren’t going to tell you if they’re short on cash. You need to do your due diligence. This is where outside help such as a fractional CFO can deliver insight and direction, so you don’t have that box of blank checks ready for your receptionist’s desk.