Credit control is the process by which businesses extend credit to customers in order to make it easier for them to purchase a good or service. This could be by delaying payment or breaking down the total purchase amount into more manageable installments. This strategy drives up sales but it’s important to be careful about how you extend credit, and to whom, or you could end up in financial hot water. In fact, research by Graydon found that over half of business bankruptcies are related to poor credit management. We’ve put together a guide to credit control for small businesses to help you manage this process wisely.
Credit Control Policies
It’s important to choose the right credit control policy for your business. Broadly speaking, there are three policy levels:
- This is a low-risk strategy whereby credit is extended only to those customers with a strong credit history.
- This is a medium-risk strategy where a business extends credit to a larger proportion of customers.
- Liberal. Under this policy, a business extends credit to most customers, generating more sales but running a higher risk at the same time.
If you are aiming to gain a large market share, then a liberal credit control policy may be better suited to your business. However, if you are already experiencing cash flow issues or operating at a low profit margin, it may be more prudent to be more restrictive.
Credit Control Factors
There are four primary credit control factors:
- Credit period: the length of time a customer has to pay for a good or service.
- Cash discounts: when a business offers a customer a discount if they pay in cash before the end of the credit period. This helps with cash flow.
- Credit standards: This is the set of standards used to determine whether or not a customer qualifies for credit.
- Collection policy: the steps a company will take to collect late payments. Tough policies mean faster collections but may also drive customers away.
The best practices vary from business to business; some will profit from more restrictive measures, whilst other businesses may be in a better position to be more liberal. It’s best to consult your accountant, CFO or financial director when deciding on how to best implement the above credit control factors for your business.
How Creditworthy Are Your Customers?
Before agreeing to extend credit to a new customer, you should check how creditworthy they are. Consider the following:
- Can your customer afford to pay the full amount within the agreed-upon time frame?
- How likely is your customer to encounter financial problems in the near future?
- How strong is their credit history? Do they have a record of late payments?
Do not overlook these important questions in your haste to make a sale, or you could find yourself encountering some serious cash flow issues as a result. You should always perform an online credit check before issuing credit using agencies such as Experian. Often, these agencies charge extra for more detailed credit reports, but this information can prove extremely useful and so it may be worth the additional fee.
Before extending credit to a business, you should obtain trade references from two or more of the company’s regular suppliers to ensure that they are creditworthy. Each reference should include the supplier’s name and details, as well as a record of late payments or exceeding credit limits.
It’s important to carefully arrange your credit terms to protect your business. You should decide on the maximum amount you will offer your customer, the credit period and any late fees or early payment incentives. It’s important to make everything crystal clear to your customer at the start so that they cannot blame late payment on a misunderstanding due to poor communication. It’s also worth considering hiring a business lawyer to draw up a sales contract to ensure that your terms are watertight.
Getting your credit control right is crucial to the success of your small business. When implemented correctly, credit control can boost your revenue and encourage repeat business. However, poor credit control management can result in cash flow problems, mounting debts and a lot of stress. Therefore, you should proceed with caution and take the time to arrange credit control terms that are most beneficial to your unique business.