Deciding whether or not to provide a customer with a line of credit can be complex decision. On the one hand, supplying a line of credit to customers can establish enormous goodwill and result in immediate orders for your products or services. On the other hand, a line of credit can become a major liability, one that puts a strain on your company’s cash flow and has the potential to adversely affect your bottom line. So how do you establish a safe middle ground where you believe your company’s assets are sufficiently protected, yet you are extending enough credit to appear as an attractive supplier to your customers? Striking that balance is not easy. In fact, you may feel like you need an online MBA degree to understand how to do so, but extending a line of credit to customers says a lot about how much you value their business and your desire to strengthen your relationship with them.
How Do You Decide?
Extending a line of credit to a customer is in many ways offering them an unsecured loan. You will send them your products or perform certain services in exchange for their promise to repay you. Initially, it’s important to assess whether your company can afford to extend credit. Do you depend upon customers paying their invoices upon receipt in order to do things like make payroll and pay federal taxes? If so, then extending lines of credit may not be the best option for your business.
However, for some companies, such as an office supplies provider, extending credit is simply part of doing business. A customer orders office supplies and then receives a box with the items ordered plus an invoice that notes, “net 30″ or a similar time period. That way the customer knows that he must pay the amount shown on the invoice within 30 days of the invoice date or risk being charged penalty fees or forfeiting credit benefits.
Considerations for a Big Company
Large corporations may offer extending lines of credit to customers as a matter of course because it is simply a reality of their business environment. The system works well for large companies because they often have sufficient cash flow and means of obtaining cash in the form of loans and other financing. They are not harmed by taking the risk of extending credit. They also tend to have the resources and connections to get information on the reliability of their potential credit customers.
Considerations for a Small Business
Yet the situation can be quite different for small businesses. Many small to mid-size businesses live or die by the timely payments of their customers and are constantly seeking methods to improve them. For these businesses, extending a line of credit, especially for a longer time period (like 60 or 90 days) can seem insurmountably risky. However, taking the risk of extending credit may be just what the business needs to boost its growth, in which case it’s nearly impossible to not take the risk.
When to Take the Plunge
When extending credit, it’s always best to proceed with caution. There is no such thing as too much information when you are putting your business’ profitability on the line. With some well-established, long-time customers you may already have all the information you need. If you’ve been doing business with them for years, you know whether or not they meet their financial obligations in a timely manner and the ongoing nature of your business relationship with them is such that it behooves both of you to continue on in a reliable manner.
However, it may be a different story for new customers who have not yet established a history of good payment with your company. These customers may represent more of a risk, but there are some ways you can protect your business before extending a line of credit. Check out the new client with a credit reporting firm. Find out if they have a history of paying their obligations on time. Getting this information from an impartial source can prove invaluable. A credit reporting agency has no reason to give a biased reference and will provide only a dispassionate report of relevant data, instead of the subjective opinions one might receive from a client’s references.
On that note: ask the client or customer for financial references, such as bankers and accountants who have done work with them in the past to determine whether those relationships were successful and if obligations were met. Similarly, it is not out of line to ask for recent financial statements from business clients. Balance sheets and operating statements say a lot about a company’s performance. A strong financial performance over the last couple of years indicates that the company will likely be able to pay your bill at the appropriate time.
If any of the results of your investigation can be construed negatively, then it’s probably best not to extend credit to that particular customer. A company or person that has a history of not meeting its financial obligations is likely to leave your business in the lurch. Let them be a headache for someone else. Of course, even clients and customers with a poor credit history should be given a chance to redeem themselves. As they do business with you over time and establish a reliable reputation with your business, you may come to reconsider your decision and offer them a line of credit.
Small and mid-size businesses are in no way obligated to offer a line of credit to all customers. Those who do offer lines of credit tend to value the flexibility of being able to pick and choose which clients are worthy of the risk and the ability to determine the precise terms of payment. No matter what you choose to do, keep in mind that extending a line of credit to a long-standing customer is an expression of good faith in your business partners and in the future of your relationship with them.
About the Author
Kate Manning is a business major who has worked under others and as a self-employed entrepreneur. She currently owns and manages her own business in Washington state.