For many small businesses, cash or debit card is the primary method of payment from their customers. However, it has become increasingly popular for SMEs to extend lines of credit to their customers as it can result in increased sales and profitability.
Business owners who are reluctant to incorporate credit as an alternative form of payment usually cite delayed payment as a reason for doing so.
This is a legitimate concern as money is not received for the good or service immediately and can place pressure on cash flow cycles.
Furthermore, if your customers don't pay up, it can cause further stress and result in a lengthy settlement process.
If a business is experiencing these problems, it can indicate that you are extending credit to the wrong customers under the wrong circumstances. A poor credit policy can also have a shrinking effect on business growth.
So what can a business do to ensure they successfully extend credit lines?
Identify the right customers
One of the biggest mistakes credit providers make is to grant credit to those posing an uncertain or high risk without doing a thorough credit check of that individual.
Most times, businesses are so focused on servicing their customers' needs that they overlook their creditworthiness. Some customers who appear to be good candidates may in fact have defaulted on their payments or have taken too long to pay small amounts.
By credit checking their customers, they will be able to see a range of information such as bankruptcy, judgement data, defaults, past credit enquiries and directorship data- all of which will help you make an informed decision on whether to extend credit to an individual.
Have a good credit policy
In addition to conducting credit checks on customers, you should also have a clear, consistent and appropriate credit policy. Set a credit limit in accordance to the level of risk your business can be exposed to before running into bad debts.
This should not be too low as to suppress the quantity a customer can purchase from you, but not too high that your business cannot afford to wait for payment.
In addition your business should also determine a contingency plan in the case your customers cannot pay up, such as if you will send overdue notices or engage a debt collection agency to collect your payment.
Your payment policy should incorporate this, as well as terms of credit (billing cycle, any early payment discounts, penalties for late payment and maximum credit limits). In this way, you can ensure that your credit policy sets out the responsibilities of the credit provider and the customer.