1 How to Build and Use Credit Policies to Your Advantage
2 Customers are your bread and butter, but they can also be your biggest risk. Now more than ever, small businesses need to take a page from some of the world s largest companies to reduce exposure to bad customers, with credit policies and monitoring that can help spot potential issues or new opportunities with existing customers. This brief outlines the steps to take to establish and apply a credit policy that works for a small business, including: 4 3 steps to building a credit policy 4 Signs that something is changing for better or worse with a customer 4 How to evaluate information sources to be sure you getting all you need without breaking the bank Credit Policies: Reducing Risk, Strengthening Cash Flow, and Giving You Peace of Mind There s a lot that keeps the small business owner awake at night. Can I meet payroll? Can I perform necessary maintenance on my equipment or facility? What s my competition doing? How can I innovate? Will this be the year I finally turn a profit? The list goes on and on. The best possible answer to all of the questions is financial well-being. New customers. Expanded opportunities with existing customers. Getting paid on time, all the time. Credit policies can go a long way to ensuring stable and predictable cash flow. You don t have to be a trained risk or credit specialist, and your policy doesn t have to be intricate and complex. You just need to have one. Here are 3 steps you can take to build a credit policy that works for your organization. 1 Determine What Level of Credit Extension You Can Afford The first step in establishing a credit policy is to understand just how much credit you can afford to extend. With just a little thought you can create a framework that s grounded in the deep knowledge you have about your business, your own tolerance for risk and your experience with customers and payments. Start by defining: a standard set of information you will get to understand your customers capabilities and assess their willingness to pay. what steps you will take if they don t supply that information. the maximum line of credit you will extend to any customer. how long you will allow for payment, what early payment discounts you ll offer, and whether to offer them at all. clear penalties for late payments. Once you have got a credit policy in place, filter the information through the critical questions of how important is the customer within the context of my current portfolio? and do my margins support the actions I am going to take? In this way, you can make the most informed decisions about customer opportunities on a case-by-case basis. You might also consider delegating the task of evaluating a credit application to someone in the organization that you trust (you might just be too close to the issue to be truly objective). 2
3 Collecting most if not all of the information here, will give you a much more complete picture of a credit applicant: Full legal name and address Date of founding The form/type of business The company s bank A listing of the applicant s suppliers (to gather trade references) Profit and loss statement from the last fiscal year A listing of current assets including: inventory, cash on hand,accounts/notes receivable, etc. and fixed assets including buildings, land, fixtures and equipment A listing of current liabilities, including accounts/ notes payable, accrued taxes, payroll accrued, etc. and long-term liabilities Total net worth Value of machinery or equipment held under lease Most recent audit and dates of latest inventory count Dollar totals of insurance, including liability, fire, etc. 2 Trust, but Verify Small business success is built on relationships. At the heart of every entrepreneur, there s an optimist, who sees almost any opportunity as a good one, and more often than not, finds it hard to say no when a sales opportunity comes in the door. It makes sense, of course signing a new customer means more revenue, which means new capital to put to work meeting payroll, paying suppliers and maybe, just maybe, expanding with a new hire, a new site or a new piece of equipment. But more often than anyone would care to admit, the potential and the promise fall short of the reality. Beyond the handshake, you need to know and have independent validation of: Who is on the management team? How long has the management team been in place? Who are some of the company s customers? How balanced is the company s customer portfolio? Who are some of the company s suppliers? What s the firm s payment history? Does it have a well-establish trade record? How long has the firm been with its bank? Are there are any outstanding lawsuit, liens or judgements against the company? Are there any corporate family relationships that mean this prospect is part of a larger, profitable organization? Small business owners need to trust their instincts, but back it up with cold, hard data than can reduce customer risk. With a deeper data set on prospects, you ll be in a much better position to manage the relationship for financial stability, and be confident in your decisions. Beware the Google-trap Online search and social networking sites have been a boon to small business owners. With access to company profiles at the click of the mouse, many small business owners rely on Google, LinkedIn and other online networks to review a prospect searching for evidence that the company is legitimate and possible connections that can provide back-door references. It s important to recognize that while you might be able to confirm a location, and maybe even a website, the information available in search is widely self-supplied or marketing driven. While enough to establish a baseline, the information gained through online search is just the tip of the iceberg when it comes to getting the information you need to make the best possible credit decisions. 3
4 3 Make it Possible to Always Say Yes Managing Marginal Customers In the current economic climate, it may simply seem impossible to say no to a prospective customer. The good news is that credit policies that require getting a detailed set of information about the customer, may in fact make it easier to say yes. Marginal customers may have potential the key is to manage against that reality to make the sale successful and provide a basis for the relationship that supports success. Every customer has potential. You need to recognize which opportunities come with risk, and then use strategies to limit your exposure, including: Require progress payments to mitigate part of the risk Limit exposure by shipping only one order at a time Employ security instruments such as deposits, guarantees, Letters of Credit or Uniform Commercial Code filings Business Conditions Evolve: Your Credit Strategy Needs To As Well It s easy enough to sign a customer, set the credit terms, and then never take the time review the payment history and evaluate the current line of credit you ve extended Customers are just like you when times are good, their business grows, giving you an opportunity to sell more and expand your relationship with them. When times are tough as they have been for the past few years there will be signs that can give you an early warning that there may be a problem and you need to investigate further. Not all signs of change in a customer s condition are as obvious as receiving frequent requests for changes in payment terms. Knowing the signs to watch for and what they mean can make a real difference in how quickly and successfully a business grows. So how does all of this translate into the dynamics of a customer portfolio and specifically, a credit management discussion. 4 hours a Customer s ownership changes 8 minutes a Customer files bankruptcy 3 minutes a Customer ceases operations NACD Southern Regional Annual Meeting EVERY 2 minutes a new business opens 14 seconds a judgement is filed against a customer 8 minutes a Customer s risk profile changes 2 minutes a directorship (CEO, CFO, etc.) change occurs Event Good News Bad News You re paid on an accelerated timeline Change in location/ real estate transaction Change in a banking relationship Change in leadership You can put that money to work much more quickly. Even better, the customer may be thriving giving you an opportunity to expand your business with them. The customer s business may be booming and they ve expanded; a good time to see how you might be able to help them do more. The customer may have found a lender more enthusiastic about their potential, that s given them an expanded line of credit. Maybe you should, too. There may be some new leadership with an expanded vision, and an ambitious plan for growth the perfect time for you to demonstrate for the value you can deliver now and in the long term. 4 If you are critical to the customer s ability to do business as usual, on-time, or early payments may actually indicate that the company is struggling to do everything possible to keep the doors open, or raise their credit profile in advance of seeking a loan. It might be that they ve had to downsize and you need to get in line first to ensure your account is settled. The existing banking partner may have ended the relationship due to higher risk. The company s board may have decided that it s time to throw out all the old including you.
5 It s important to both monitor for these and other changes that have the potential to impact your business and to establish a regular review of the financial aspects of the relationship, ideally annually. When changes occur, the simplest course of action is to pick up the phone and speak to the customer about what s happening. You can also do some digging on your own or engage a service that specializes in investigating businesses. Choosing a Credit Information Partner A credit reporting agency and business information partner can be a small business owner s best ally in helping protect all you ve built from a cash flow crisis. Maybe you do a credit check when you are engaged with a prospect, but as has been shared here, there s a great deal more information you can get and use to fuel decision making. When evaluating a resource for credit information, you need to consider these factors: Data integrity: Where does it come from? What processes and requirements does the provider have in place to validate the information? Data breadth and depth: How many sources of trade payment behavior does the provider use in developing the customer profile? Customer-centricity: How flexible is the provider in terms of working with you as a small business? Can you buy just the reports or information you need? Choosing the right information partner means you ll get the insight and intelligence you need to make smarter credit decisions, quickly and confidently. More importantly, you ll protect your business from the risks associated with bad debt, and you ll be better positioned to invest in growing the business. A Brighter Future Establishing a credit policy, and developing a systematic and scalable way to evaluate customers stability and their ability to pay for the goods and services you provide can be incredibly beneficial to any small business looking to thrive in today s volatile economy. With sound credit policies in place you may see: Larger sales volume: customers may buy more at the outset if they know they can pay over time. More sales from existing customers: when you know which customers are good financial partners, you have a clearer view of which customers you should invest more time with to win more of their business. New customers: credit terms may entice customers who hadn t done business with you to try your goods or services. Competitive advantage: you may be able to take a greater share of the market with terms that are more attractive than a competitor. With the right safeguards in place, small business owners can focus on what s best about being an entrepreneur: hiring new employees; expanding operations; finding new partners; developing and delivering innovative products and services and delighting customers. About D&B and Small Businesses D&B s global commercial database and solutions provide small businesses with the tools and resources needed to succeed. Small businesses have relied on D&B for 172 years to help build and monitor their business credit and to confidently make business-impacting decisions. In 2010 alone, 10 million small business records were added to D&B s Global Database. For more information about D&B s solutions for small businesses, visit To learn more about how D&B can help your business success call us at or visit us at 5