Going from Cash Only to Extending Credit to Customers

We are seeing a trend of some companies who operate on a cash basis starting to extend credit to their customers. The necessity of extending credit is primarily being driven by the need to retain large volume customers or lose them to a competitor.

Large volume customers don't want the hassle of having to pull out a credit card, do an eTransfer, or the inconvenience of cash, for every single transaction. The more transactions these customers make, the more irritated they become. It doesn't take long for large customer to migrate over to a competitor who will gratefully extend them credit and eliminate the hassles of multiple transactions for themselves and their staff.

For many companies 80% of their revenues come from 20% of their customers. It is these 20% of customers who make high volume and high dollar transactions. It is these customers that the competitors try to lure away with the convenience of extended credit.

All it takes is for a company to lose a couple of big customers to realize that if they want to retain high volume customers, they have to be competitive. However, extending credit to the 20% comes with bigger risks and costs. If a large volume customer defaults on payment it can cripple a company financially.

The biggest mistake companies that are new to extending credit make is not having a proper credit application, or credit agreement. Instead of incurring the minimal costs of a proper credit application or agreement, they just start extending credit and see how it goes. Companies that extend credit with this strategy are sure to get burned big time, sooner or later.

They learn the expensive lesson that a proper credit application-agreement can mean the difference between getting paid, or a write off. All of a sudden, the cost of creating a solid application-agreement doesn't seem so expensive. A professional credit agreement-application reduces risk and extends the ability to get paid when a customer goes sideways.

The second biggest mistake is failing to verify the information provided by the customer, or check for negative information never provided. The bigger the customer, the higher the risk. Before establishing a line of credit, it is wise to know more about a customer's financial stability.

If a credit check reveals some red flags there are ways to still extend credit, while reducing or eliminating potential risk. Often a personal guarantee or indemnity agreement will drastically reduce the risk of dealing with a limited company. There are other remedies that can also be used to reduce the risk of a potential write off.

If your company is debating on going from cash only to extending credit to all or some customers, it is wise to do some basic research. What terms and conditions are offered by competitors? What is the cost of carrying an accounts receivable? Will the increase in business offset the cost of underwriting financing for your customers?

Operational procedures also need to be considered. If an account is delinquent who will follow up for payment? At what point should a delinquent customer be cut off? What is the process for resolving disputes?

A credit application, or agreement, should be tailored to your specific industry and address how potential billing problems are resolved. A proper agreement or application protects your interests and determines what you can and cannot do when pursuing payment. If you are carrying large dollar accounts, a professional credit agreement can mean the difference between getting paid, or taking a massive financial hit.