A credit policy that stays on the shelf is destined to fail - bringing it to life is essential to success. Over the past weeks, we have seen how to develop a credit policy and what to watch out for, but this week Dun & Bradstreet shows you how you can start implementing this policy.
We can start by talking through the Four Cs of credit management: character, capacity, Capital and conditions of the times.
Before extending credit to a prospective customer, you will want to look into the Character of the business, that is, the background, history and traits that will determine if the customer can pay you back for the goods and services provided.
The recent spate of construction firms entering administration brings to attention the importance of knowing who you are dealing with before providing them credit - this can be an extremely costly and stressful experience if you do not. Don't make the mistake of assuming that a large company has the cash flow to sustain itself, as insolvency can strike firms of all sizes.
Here are some elements that are easily researchable, either via the company website, Internet or through a credit reporting agency:
- Company name and legal form
- Company history
- Product range
- Litigation or bankruptcy issues
- Board of directors (experience, length of time served)
- Financial worth
A company website will probably exclude negative events in its history, but signs that the company is in financial trouble can include project hiatuses or projects that have commenced years ago but have not been completed; or multiple changes in ownership or directorship. The news section or media centre of a company website can also notify you if it has entered administration, or of any board changes.
Litigation information and financial worth may be more difficult to obtain, particularly with private organisations, so it may be worthwhile obtaining a financial report or credit report from a third-party agency.
This ability to make repayments, or capacity, will affect how and when you get your money back. Smaller businesses may mean that principals have multiple obligations and work across sales, production and finance, often diluting their ability to manage effectively. Large firms also have their disadvantages - bureaucracy and red tape may mean that an invoice takes longer to pass through the reporting hierarchy and hence take longer to get paid.
Consider how the business manages its invoices before extending credit, and how long its payment terms are. A business that operates beyond standard 30 day terms could place a strain on your own accounts management process.
You should also consider if the business has any major seasonal fluctuations or periods of low revenue due to lowered demand for their product, such as firms that only sell in the summer, as this may affect their ability to pay you back.
A customer that is unwilling to pay is very different from one that is unable to pay, as an unwilling customer may mean that the good or service provided was not up to scratch, while a customer unable to pay is a clear sign of financial distress. While there is little chance of predicting the former scenario, the latter scenario can be preventable with some knowledge of the customer's financial solvency and payment background.
Bank and trade references may be a good idea as well. This way, you can contact the relevant references to enquire about their ability to pay. If the customer has a parent company this may mean that you can secure a guarantee, although you should also consider any inter-company loans that may affect their solvency.
Even if the elements listed above have all checked out, you should take one last step to ensure that you are researching all possible payment scenarios.
Industry performance and patterns, as well as the broader economic picture, can reveal some of the problems a potential customer is facing. The European debt crisis, for instance, could severely hit businesses with exposure to Europe or its major trading partners, while a struggling manufacturing or construction sector may speak to inherent problems within the industry or lowered demand across the board.
Keeping abreast of any economic changes are more important than you think, and along with assessing the ability of a potential customer to make repayments, this can help you make an appropriate credit decision.