If your business sells products, you have the option of allowing customers to pay on a future date. Not providing credit options to customers might be an incentive to move on to your competitors. This might be a good idea if you need to generate a large customer base, but it will also require working with credit accounts and accounts receivable. Additionally, you must find the right balance between higher sales and the cost of extending credit.
If doing so is worth it, your next decision is determining which customers should receive this benefit. While you may need to extend credit to get some business, you do not have to extend it to every customer. Make wise choices to avoid the headache of extending credit to the wrong customers. Limit your risk by investigating the credit history of customers.
Extending credit to customers gives them an option to buy your products or services today and submit payment at a later date. Essentially, this is no different from accepting checks or credit card payments for the same products or services. Invoicing customers also assumes that customers will have the funds to pay on a date other than when you fulfill their purchase.
When you extend credit to customers through checks, you are responsible for verifying their payment information. Any risks associated with accepting this form of payment rests on your business. Accepting credit card payments does not come with risks to your business. Instead, the credit card company that issued the card manages the risk.
Industries such as manufacturing or construction extend credit through invoicing customers. Although this might not be practical for every business, it is an acceptable practice in the industries. Weigh the risks and rewards associated with extending credit to your customers.
In general, you should have every customer complete a credit application before extending credit. An application provides written proof that customers qualify for a credit extension. You also have a paper trail if legal remedies are required to get payment. Include the following requests for information on the application:
Filter the information through one of the credit reporting bureaus. A credit check through Dun & Bradstreet provides a snapshot of the creditworthiness of the business customer. Once the customer completes the application and you grant approval, you will need to set up a customer account. Send out invoices to customers for every purchase. You can do this manually or buy an automated software system to help you manage customer accounts.
Now that you have set up customer accounts, you need a system to manage the receivables. Paper profits, in the form of invoicing customers, look good. However, they do nothing for your business bank account if customers are not making timely payments. Cash flow remains king and you do not want to have a backlog of unpaid invoices, which will directly affect paying your business expenses.
Sales are not fully counted until money is received. You want to manage accounts receivable effectively to avoid financial issues. If you extend credit, net 30 days should be the maximum period; giving customers 15 days is preferred.
Whichever payment period you grant, make sure it is clearly written on customer invoices. Additionally, your accounts receivable plan should keep track of who pays and who has not. Follow-up with customers about any unpaid invoices as soon as possible. Use this basic process to manage your accounts receivable and improve cash flow.
Get cash. You can build business relationships by extending credit, but you also become a lender to customers. If you have a retail business, you most likely run a cash business. Whether your customers pay with a credit card, check or cash, you receive payment almost immediately.
Running a service business or business-to-business operation is slightly different. Most of your customers expect to pay for products or services later unless you require payment up front. Ask for payment up front to turn an invoice into cash.
Set credit limits. If you have a small customer in terms of sales volume, base the credit limit on the maximum amount they can afford to pay. For larger customers, extend their credit limit based on how much risk your business can reasonably handle. Business finance experts recommend not more than 10 to 15 percent of the total sales one customer generates. You could ruin your company by extending 50 percent or more of your total sales if the customer cannot pay on time – or at all.
Use discount incentives. Many businesses find that offering discount incentives to customers leads to prompt payment of invoices. A customer that has a cash flow problem will not pay early, but those that do are usually happy to pay an invoice within 10 days to receive a two percent discount. You can vary discount percentages based on customer history, the amount of the invoice and your immediate cash flow needs. Keep in mind, however, that discount incentives might improve your cash flow but also reduce profits.
Request percentage or progress payments. If some customers are unable to pay cash, require that they pay a percentage of the total price when they receive products or services. You might find this particularly helpful if you are in an industry such as construction where buying supplies ahead of time is necessary. Even if your business does not require purchasing supplies to fill customer orders, you can still ask for a retainer.
Progressive payments are another option to extending credit and managing your receivables. You could request a 25 percent deposit to begin work, an additional 25 percent when the initial draft is approved and the remaining 50 percent once the work is completed.
Once you establish standard procedures, follow the practices consistently. Include internal guidelines for handling overdue receivables. Sometimes, a customer just needs a courtesy phone call or email that reminds them payment is overdue. Others might need the threat of litigation to pay their invoices. Still, some customers might stop doing business with you if they receive a litigation letter. Try to keep the communication doors open as long as possible to collect monies owed.
Managing credit accounts and accounts receivable effectively is one more important factor to having a successful business. Determine what is best for your business, implement the right strategies and stay on top of customers’ payment habits.
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