Finding Creditworthy Customers

Most companies have payment terms, such as net 30, associated with their invoices. Net 30 tells clients that they must pay their bills within thirty days of the invoice date in order to keep current.
 
In addition, companies set credit limits, or the maximum amount of money that a customer can spend when taking advantage of credit terms. In essence, when companies extend a loan, they trust their clients to be responsible about repayment. Of course, there are always exceptions to the rule. How does a company decide whether its clients are going to be creditworthy customers?

Checking Customer Credit

Most companies check their customer’s credit before giving them payment terms. Typical methods of checking customer credit include credit references, credit reports and financial statements.

Credit References

Providing a company with credit references is one way for the company to verify your creditworthiness. With credit references, a potential client provides the company with names of several business associates or partners. The company will then call the businesses and ask for information such as:
  • How long have the companies been doing business together?
  • Is the potential customer paying on time?
  • What kind of credit terms is the potential customer currently getting?
Keep in mind that this type of inquiry does not always provide a complete picture, as the potential client may be selecting associates that will indiscriminately vouch in his or her favor.
 
As part of checking credit references, a company should also talk to the potential customer’s bank. Key information that the company will want to find out includes:
  • how long the client has been with the bank
  • if the client currently has a loan with the bank
  • whether the client is paying back the loan on time.

Credit Reports

A credit report can cost between $15 and $1,000, depending on how complex the report is. Reports can be purchased from a credit bureau. A credit report will provide the company with all sorts of important information, including:
  • any bankruptcy filings against the client
  • any court judgments against the client
  • any fictitious names the client has used
  • any tax lien filings against the client.
In addition, a credit report will give the potential client a credit rating or credit score that will help a company determine the client's credit reliability.

Financial Statements

If the potential client is a publicly held business, the loan-giving company can request a copy of the client's balance sheet. A balance sheet can give the company an idea of the health of the client company while also allowing the financial institution to check the client’s current ratio, or the relationship of current assets to current liabilities. Most companies will look for a ratio that is more than 2-1.
 
In some cases, extending credit to a new client might be a bad choice for a company. A company may choose to offer the new client services on a COD or cash-in-advance basis, with the opportunity to open credit in the future as the relationship progresses.

Credit Management Services

Credit management services are another option for facilitating operations between a company and clients. A credit management service may be able to:
  • assist in collections
  • create an automated credit processing system
  • identify risks
  • improve monitoring of borderline risk accounts
  • increase the speed between processing new customers and releasing first orders
  • keep the conditions for credit consistent.

A credit management service should be able to improve a company's cash flow. It may also be able to provide valuable sales leads and point out opportunities for cross-sales or up-sales.

Resources

AllBusiness.com Inc. (n.d.) Checking a Customer’s Credit. Retrieved March 27, 2008, from the AllBusiness.com Web site: http://www.allbusiness.com/business-finance/cash-
management-collections/435-1.html.
 
AllBusiness.com Inc. (n.d.) The Role of Credit Bureaus. Retrieved March 27, 2008, from the AllBusiness.com Web site: http://www.allbusiness.com/business-finance/cash-
management-collections/1366-1.html.
 
Dun & Bradstreet, Inc. (2004) Credit Management Services. Retrieved March 28, 2008, from the DnB.com Web site: http://www.dnb.com/product/CMSfactsheet.pdf.