Credit and Collections for the Small Business
November 2004
This month, we start a multi-part series on credit and collections issues for the small business. Credit decisions are often made as an afterthought once a sale is closed, or worse, based on customer expectations or what may be considered "industry standard". Credit policy should always begin with what is in the best interest of your business, its cash flow and profitability. A strong credit and collections policy will not only help you extend terms to the right customers but also be a powerful selling tool for your sales force. Also, it provides credibility with your banker when it's time to finance the receivables that accumulate through your extension of trade credit. Whether you realize it or not, if you are not charging up front or collecting when the service or product is delivered, you are actually extending credit and should have a credit policy and process in place.
Think of your credit policy simply as your business practices relating to how you want to make your customers pay what they owe you. It's really just a system for determining how you are going to collect payment from your customers. It should be established with an eye towards both internal factors -- such as profitability, cash flow and financing -- as well as external factors like customer credit worthiness, industry norms and special promotions. Many businesses inadvertently become "banks" for their clients as a result of their loosely established or poorly managed credit policies. This can cause severe cash crunches and hamper your ability to grow.
If you imagine all the possible credit policies that you could adopt, you have a wide spectrum to work within. At the relaxed end of the scale, you could establish a completely loose credit policy that would allow customers to pay for your goods or services whenever they could. On the most stringent end of the range, you might implement a completely closed credit policy that would always require payment in cash up front before the goods or services are delivered. Where you establish your business's credit policy along this scale will depend on both the internal and market factors affecting you and your customers. In future issue, we will discuss how to go about establishing the right policy for your particular business.
Remember, if you decide to extend any form of credit, get comfortable with the idea that you will have customers who won't pay you on time or even pay you at all. It's unavoidable. No matter how complete your application process or good your judgment of credit worthiness, you can't always identify the non-payers. Not all of the customers who don't pay you on time are bad credit decisions. Some may be unable to pay you for any number of reasons beyond their control, such as an unexpected emergency or industry downturn. Some may have even have been stiffed by their customers due to poor credit management and therefore are unable.
The only foolproof way to avoid bad debts is not to offer any credit. Since that isn't practical for most businesses, you'll have to do the next best thing, which is to take all reasonable precautions to protect yourself and to ensure that you're not extending credit to the wrong person or business.
Taking precautions to help you reduce the chances that you'll extend credit to someone who doesn't pay his bills is an extremely important step for a small business owner. One bad debt can strain your cash flow or, in extreme cases, put you out of business. Just don't forget that the decision to extend credit to customers does not mean that you have to extend credit to every customer.
A credit policy is an integral part to your company's success. Establishing this policy gives your sales staff another tool and gives your customers a way to pay and a clear understanding of when and how they are to pay for your products and services. Some customers may abuse this policy, but taking precautions and being selective about the customers to whom you extend credit will help protect your business.
Next month: The different types and methods for extending credit to your customers.
