Trade credit, or business credit, is merely the extension of credit from one business to another and is a tremendously large lending source, and an incredibly important part of the business machinery. If your business has decided to extend credit, or is part of a industry in which the extension of trade credit is basically mandatory, a formal written credit policy is a good idea. I recently briefly discussed why that is, and what a credit policy actually is, here.
Credit Policies Should Include a Credit Application Requirement
When a written credit policy is drafted and implemented, one important part should be a formal credit application. Standardizing the credit process by having every potential credit customer (every customer can be a credit customer in some industries) fill out a credit application helps to create a procedure by which the potential risk [quote float=”left”]The first step in managing credit wisely is to make informed decisions about which parties should qualify, how much credit they should be extended, and the terms thereof.[/quote] associated with extending credit can be mitigated. Even with the security provided by mechanic’s liens or bond bond claims, the first step in managing credit wisely is to make informed decisions about which parties should qualify, how much credit they should be extended, and the terms thereof. Depending on the information in the credit application, the payment terms may be modified by customer.
A well thought out credit application should generally include, among other things, a request for credit references (the customer’s bank and other creditors). By contacting the references listed, a business may be able to weed out potential problems before they occur. A step as simple as this can be the difference between a smooth cash flow, and a interminable payment collection battle. While it may hurt to turn down a sale if the results of the credit application are not sufficient to meet your policy guidelines, the actual cost of a non-paying client is much higher than the amount of the lost sale. I’ve mentioned several times that a good, structured, and utilized lien and notice policy can allow for a less restrictive credit policy because the debt will be secured. This is true. But, no matter how secure the debt is, there are some customers to whom you will just not want to extend credit. Think of it like this: a mortgage is secured by property just like a mechanic’s lien – but that doesn’t mean everybody qualifies for a big shiny new loan. Obviously there are differences: business & individual, net-30 & 30-years, but the idea holds true – sometimes being secured against non-payment doesn’t mean the risk of non-payment is acceptable. Even if you get paid later, the blow to your short-term cash flow may be too much to handle.
Credit Reports Are a Good Idea
As well as contacting the credit references listed in a potential customer’s credit application, it can be a good idea to run a credit report. Trade credit bureaus take information about credit transactions and create business credit reports. A business credit report functions the same as a individual credit report; it represents the party’s ability to pay a debt. It uses a different scale, but the effect is the same, the higher the score, the more credit worthy the party. There are a few major business credit bureaus through which you can receive a business credit report, including:
- Dun & Bradstreet
- Experian Business
- Equifax Business
Credit reports provide a nice snapshot to help make credit decisions, and should be a standard part of a proper credit application.
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