When you give your customers the option of purchasing your company’s products and services today, but pay for them later via check or invoice, you’re essentially extending your customers credit. While the credit card company typically manages the risk when customers pay you through a credit card, when you allow customers to pay you through an invoice or check, the risk falls more heavily on your shoulder.
The U.S. Small Business Association provides best practices for extending credit to your customer tips to help you minimize your risk.
1) Evaluate Credit Risk
Many larger companies have a dedicated credit risk department whose primarily role is to evaluate the financial health of its customers, and decide whether or not to extend credit. Although most small businesses usually don’t have the resources to staff an entire credit risk department, it may behoove them to run a credit report on its customers. You can run credit reports on individuals by contacting Equifax, Experian, or TransUnion. As an alternative, companies like Dun and Bradstreet and Standard & Poor’s will provide you with credit rating information for a fee.
2) Establish Detailed Credit Policies
One of the best practices for extending credit to your customers is to establish, communicate, and consistently apply clear-cut policies relating to payment from your customers. When invoicing your customers, indicate when the payment is due, when it is considered late, and what the interest, penalties, or fees are if their payment is delinquent. Your payment terms and conditions should include your procedures for collecting defaulted payments.
3) Understand Consumer Credit Laws
The Federal Trade Commission (FTC) is the agency responsible for enforcing U.S. consumer protection laws. These laws and regulations are primarily designed to protect the consumer by giving all consumers an equal and fair opportunity to not only obtain credit, but resolve disputes over credit or billing errors. Among other things, these laws dictate how aggressive you can be when collecting a debt, the time frame allowed to respond to billing mistakes, and provide uniform calculation and disclosure of the cost of borrowing.
4) Be Persistent in Collecting Payment
Playing banker to your customers may not be on your list of favorite things to do as a small business owner. You want to maintain a good relationship with your customer, but you also want to get paid. But if a customer becomes late in making payments, beyond adding penalties for late payment, what can you do? One thing you can do is to immediately stop extending further credit to these customers in an attempt to cut your losses. You can also employ a payment collection agency.
In the end, the best way to minimize substantial customer default payments is to establish strict credit policies and conduct thorough credit risk evaluations before extending credit. Clear communications will contribute to a good business relationship between you and clients and customers, while persistent follow-up is a key aspect in collecting debt and keeping control of cash flow.