[Editor's note: I'm heads down on a project and will have lots to share soon. In the meantime, I hope you enjoy this previously published article from one of the awesome accountants we work with here at Little Square. - Shelly]
I really don’t want to be a banker and I’m guessing you don’t either. In reality, however, any business with accounts receivable is acting as a banker. When you provide products or services to clients before collecting payment, you’re extending credit to them—which is essentially the same as lending them money. It’s critical to be careful when lending your money to your clients.
Fortunately, you can take steps to protect your cash without sacrificing good client relations. The most important step is to implement a credit policy that’s fair to your clients, consistent with your industry, and has enough teeth in it to protect your business. If you have employees administering the policy, you’ll want to make sure that they fully understand it. You should also have an escalation path for potential exceptions to the policy.
Some things you should be thinking about when you develop your credit policy include:
Who will you issue credit to? Does the company have to be a certain size? Maintain a certain D&B (credit) score? Will you check their trade and bank references? What criteria will you use to qualify your clients as creditworthy?
How much credit will you issue? When do you shut off the credit line? How much are you able and willing to risk?
What are your payment terms? You’re giving a free loan to your clients. How long will you make that free money available?
What happens when they don’t pay within terms? Will you assess finance charges? (If you have to borrow money to cover the cash shortfall in your business, your client should cover that cost.) Will you send them to collections?
What are the alternatives for those who don’t qualify for the credit line they need? If you have a good credit policy in place, you’ll likely have customers who don’t meet the criteria for using your money. You should have some policies in place to help those customers. Some options include:
Collecting a deposit upfront—the entire amount or a portion of it
Providing a very small credit limit, so the customer will have to pay any open invoices before accessing the line
Accepting a credit card and preauthorizing the amount of purchase
When answering these questions, consider your current client base and past payment experience. You’ll want to make sure that your current clients in good standing don’t suffer from your new policy. Review your prior bad debts and determine what policies you could’ve had in place to limit those losses.
Once you have a policy you like, take a look at your customer agreements and update them, as needed, to reflect your new terms. It’s always a good idea to have an attorney review your agreements and credit policy before implementing them.
Lending money is expensive and risky, but you can substantially limit your risk by implementing a credit policy that works for your business. Once you have a policy established, review it regularly to make sure it continues to work with your ever-changing business, client base, and the economy.