If you are a small business offering credit for the first time, you should build additional cash reserves to anticipate reduced cash flow stemming from your credit extension programs. This slowdown in cash flow is temporary, lasting until you start receiving delayed payments. Once receivables stabilise, your cash flow will return to normal.
So why should your business have a credit strategy? One of the most important reasons is that it can help you learn more about your key customers.
Customers reveal information about themselves when filling out a credit application with a business. It is widely acknowledged that extending credit can lead to an increase in sales. This can be the result when a buy-on-credit promotion is timed to match a marketing plan, the competitive environment or falling interest rates. Other advantages of extending credit may include:
- Customers usually spend more money with the business that offers credit;
- Customers are more trusting and may return the goodwill in the form of loyalty;
- Customers concerns over price are reduced; and
- It helps build a more financially sound customer base.
When you take a financial risk for your customers, it demonstrates that you trust them and are willing to accommodate them. Customers appreciate such professional service and respond positively. A credit policy also indicates that a business is financially stable.
A business in danger of going under does not give its customers the option of paying at a later date, while a struggling business demands payments immediately to keep its sinking operation afloat. Businesses that extend credit are not perceived by customers as teetering on the brink of bankruptcy - customers are confident that they will receive their goods and services as promised.
Credit policies increase sales for another reason. Some customers are unable to pay for a product or service in its entirety in one hit. If your customers have the option to pay for items in installments - which can be made to fit in with their cash flow - they will be more inclined to make purchases from you.
Another aspect is that customers may want to see if they are fully satisfied with a product before bringing out their cheque books. Offering a line of credit to these customers gives them the signal your business is confident about the quality of your products. Guaranteeing satisfaction makes frugal customers more comfortable with their purchases. Finally, it is a rule of thumb that customers will choose to do business with a credit-providing business over other businesses that do not offer comparable payment plans.
For more information, order Dun & Bradstreet's Guide to Cash Flow and Credit Risk here.
This is part one of the credit management series. Look out for part two next week in this section!