There are many reasons to consider extending business credit to customers. It can bring in new customers, increase revenues, and encourage buyers to purchase more in the future.
Extending credit can be rewarding and beneficial but does not come without risks. You need to know the benefits as well as the disadvantages before deciding if this is a good move for your business.
The importance of extending credit to businesses
The main purpose is to offer convenience of payments to your customers. Extending business credit to customers enables them to purchase goods and services that they want now and pay for them later, typically in 30 to 60 days. This is beneficial because the customer may not have the funds available to make a purchase and by offering credit, your company can sell them a higher-priced service and possibly make more revenue in the long run rather than from a quicker cash sale.
What are the benefits of extending credit to your new customers?
There are many benefits from extending credit to new business customers.
Staying ahead of competition – Offering a credit program is an excellent way to stand out from your competitors and build long-term relationships with your customers. Is this something that your competition offers? If not, you may want to consider it to gain exposure and traction.
Attracting new customers – One of the best reasons for extending business credit to customers is that it makes your business more attractive to new customers. Offering credit allows a company to extend its reach to a wider market and increase demand in the industry.
Emerging as an innovative company - Extending business credit can also help with enhancing your business reputation. If you have a fair and flexible credit policy it can increase word-of-mouth referrals. Most companies that extend credit are seen as thriving, successful businesses.
Increasing demand for products and services – Offering credit encourages customers to spend to spend more and build loyalty as repeat customers.
Promoting introductory products - Customers are more likely to try new products if they can get them on credit.
Offering flexible terms of sales – Extending credit enables sellers and suppliers with the ability to modify the terms of sales.
But before taking the plunge and extending business credit to customers, you consider both sides of the issue.
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The pros and cons of extending credit to customers
The benefits speak for themselves. It’s great for bringing in customers and building long-lasting relationships. However, there are things to consider, both good and bad, that can affect your decision. Offering credit at the right time can make the difference in making a sale or the customer leaving empty-handed. But if the customer is new and you’re not sure of their ability to repay, you may want to be careful in closing the deal and not jump too soon.
- You gain new customers
Your company presents a stable, financial appearance
Encourage larger purchases by extending payments
- Customers might not pay in timely manner or at all
- It could reduce your cash flow
- You may not be able to meet your obligations
- It could result in higher costs with collection and/or taking customers to court
If your customers fail to make payments on time it can interfere with cash flow and hinder your ability to meet the company’s financial obligations (vendor payments, employee wages, etc). Always consider the pros and cons of extending business credit to customers before entering into any binding agreements.
Factors to consider before extending credit to small business customers
Before extending credit to small business customers, your company should have a firm - but-fair credit policy in place. Having a policy ahead of time avoids a lot of problems later on. You will also need a way to evaluate customers who ask for credit. Credit applications and a credit check are standard procedures for most businesses that offer credit to customers. They can help you manage and minimize the risk of loss by helping you identify companies that are considered a “credit risk.”
It is admirable to want to give customers a chance to better themselves, especially new businesses, but you have to protect your own assets first. Many companies don’t use business credit applications and often end up with unpaid invoices and customers who don’t pay.
If you have considered the benefits, as well as the risks, and decided to offer credit here are some ways you can protect your interests while offering convenience and value to your customers.
Best practices for extending credit to customers
The first thing to do is ask them to fill out a credit application and request a credit history. The 5 C’s of Credit is an accurate tool to evaluate a customer for credit risk.
The 5 C’s are:
Character: do they have good references?
Capacity: do they have the ability to pay?
Capital: does the customer have financial stability?
Collateral: does the customer have inventory or equipment to cover an unpaid debt?
Conditions: how will the current economy affect your customer?
Your business credit application should include the following:
- Name of the business, physical address, phone and fax number
- The type of business (corporation, partnership, proprietorship)
- Number of current employees
- Name and location of bank accounts
- Business/personal credit history
- Other names (DBA’s) under which the company does business, if any
Credit history should be looked at and evaluated by length of time (history), number of outstanding debts (income/debt ratio), on-time payments, and whether the company has any debts in collection. The credit application and credit history should give you a good overall picture of this customer’s creditworthiness. This is how banks evaluate applicants and your company should too.
Reasons to deny a credit application:
- Late payments
- Missed payments
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What if the customer is a new business without a credit history?
New businesses may not have had time to establish a credit history yet. You can be flexible and modify the terms of extending credit, providing that they can offer proof of their ability to pay and references who will give them a good business reference.
As a business, you don’t have to offer credit to everyone. It is beneficial if you do, but remember to follow the suggestions above for covering your bases first. You can perform a credit check and only extend credit to customers who prove they can make payments on time. You can start out with a lower credit limit until they have made a predetermined number of on-time payments.
When deciding on extending business credit to customers, you will need to be aware of the fair credit reporting laws and it’s a good idea to consult with a lawyer after drafting your paperwork to make sure you are in compliance with state regulations.