So You Want to Extend Credit to a Customer?

You don’t earn your profit until you get paid for your product.  Although from an accrual accounting perspective you show a profit at the time of sale, the actual profit to you is after payment.  So please be very careful in extending credit to your customers.

If you are losing opportunities because you refuse to extend credit, read on.  If however, you are in the enviable position of not extending credit and maintaining your volume, kudos to you.  But you might want to consider accepting some new sales by extending credit, so read on.

There is no substitute for knowing your customer.  If they are not of good character in terms of their business dealings, you should probably steer clear of credit extension (and possibly credit cards, too).  If they are not ethical, they can and may find a way to cheat you.

As an aside, those of you who sell to big box stores, you may have seen some collection challenges.  Their accounts payable teams spend way too much time trying to beat you on payments.  Skipping invoices, claiming damages, and charging back for incorrect shipping procedures are just a few of their tricks/efforts.  They just try to wear you down and get credits from you.

If you choose to provide credit to your customer, you need to set a limit or high credit.  Never give more than you are willing to lose.  In case you forgot, think about Worldcom and Enron as two huge bankruptcies.  Ask your local colleagues if they thought there was a risk of loss beforehand.

Also consider industry segment and geographical risk for your exposure.  If all of your clients are in one industry, that industry can incur financial pressures without individual losses.  Same with geography.  Think oil and gas in the southwest some years ago.

There are credit services which can assist in your decision making.  Most of us have heard of D&B, and there are other services available to you.  Our industry works with NACM, and you can learn more from them.

You can also pay for credit insurance, or you can factor your accounts receivable.  We have a factor in our industry who has worked with some of us.  

And don’t forget the selling terms you offer to your clients.  Whether you discount for fast payments, accept credit cards (charging the fee is your business decision), and offer extended terms, understand how it impacts your cash flow.

For single large transactions, you can work with your vendor for creative ways to finance the sale and get some cash flow relief.

Regardless of your approach, never lose sight of your cash flow needs.  Accounts receivable without appropriate planning cannot pay your expenses.  Only the collection of your receivables will do that.