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8 Tips to Define How Much Credit to Extend to New Customers

Extending credit to your business customers is a wise business decision and a way to help build better and stronger customer relationships. When your customers know that they have the option for credit, it will keep them coming back to you for your products and services, building an inherent trust between you and your customers. (After all, an extension of credit is essentially a business indicating its trust in their client.)

But the benefits go far beyond trust. Extending credit helps eliminate price objections – this way customers don’t have to worry about whether they can find a product or service for less, or whether the product or service will fit within their budget. It can also lead to larger “per order” sales for the very same reason.

Of course, handing out credit to customers comes with some amount of risk for your business, which is why it’s important to come up with a system that helps mitigate the risk. Consider these tips when looking for a guide on how to make decisions regarding credit.

Credit Risk

Taking on risk is necessary for any business. But the answer to how much risk one is capable of taking will vary from business to business. Start every assessment of credit risk by looking at your own business and weighing it against variables such as your bottom line, your history with credit and new customers, and other important factors.

Always have a policy in place for how much credit risk you’re willing to take with new customers – ideally, a policy based on your financial position. Remember – part of taking on risk means accounting for the possibility that you might not be paid at all, keep this in mind and work with the worst-case scenario.

Do Your Research

Always look at a business credit score before doing business with them. Businesses have a credit score just the same as individuals, and checking with will give you instant access to that business’s credit score.

You can obtain plenty of information about a business using their credit score, but this shouldn’t be the end of your research. Doing a bit of background research on the business (and researching its industry) can give you a better vantage point for determining the amount of credit that makes sense to extend to them.

Reviewing the latest news and annual reports from publically held companies within the new customer’s industry will provide great insight into what’s happening in that particular industry.

Check References

One of the easiest ways to determine whether a new customer can be trusted is to ask for – and check – a business’s references. Checking references lets you know about the types of relationships your customers have with other businesses. Be sure to look out for several different factors. These can include (but are not limited to) things such as the maximum limit that someone has extended to that customer; payment terms; payment history; and the payment method that customer has used to pay off the extended credit.

If they have plenty of people who can vouch for them, and whose reports align with what you want to see, you can breathe easier extending credit. But if those references raise any red flags, you need to be aware that extending credit might not be in your best interest.

Have a Firm Policy

Start developing your policy for extending credit early, and be sure that you stick to this policy. This is not an area where you want a lot of flexibility. Some factors to include are:

  • How to handle disputes on billed amounts.
  • How to go about collecting on debt.
  • How to resolve situations where the customer can’t pay the set amount.
  • Whether you will require late fee penalties if they cannot pay on time.
  • Whether you will charge interest rates on past due amounts and what those interest rates will be.
  • Other fees – such as attorney fees, collection costs, filing fees, etc. – that you will collect if you are forced to pursue a collection action.

Having a firm policy in place protects you in the long run. A solid policy also ensures that you can make changes as needed and in the future and identify problem areas to help determine how much credit to extend.

What Are You Selling?

Taking a look at your own products and services, their value, and your past revenue to get a better idea of how much credit you can and should extend to customers.

Extending too much credit can be a problem, but so too can extending too little credit. You want to make sales, so skimping on the credit you give out doesn’t make sense. After all, if your average product sells for $3000, credit lines of $1500 are essentially useless, while a $25000 credit line for a $2000 product is overkill.

To determine minimum and maximum credit lines, take a look at your existing sales and contracts. How much does a new customer spend on average? How much does a regular customer spend within a given year? A maximum credit line should cover the costs you can expect a customer to spend (with perhaps a little room for extra spending) so long as it makes sense, given factors such as their credit history.

Know Your Terms

In addition to determining the amount of credit you will extend to customers, you should also be paying attention to the terms that you are extending to customers when it comes to credit. Balance the terms that you’re willing to set up with the amount of credit you are willing to provide, and ensure that everything is set up reasonably across the board.

For example, if you offer Net 15 terms – which means that you will be paid on the 15th day after the date of invoice – your business will need to float that cost prior to payment. Pay attention to what the terms will cost your business.

Learn What You Can Do to Protect Yourself?

Bear in mind that certain types of businesses pose more risk than others. When working with corporations, you are unlikely to be repaid for any credit you’ve extended if they default, as none of the corporation’s employees are liable for that debt. In the case of partnerships or when working with a sole proprietor, a personal guarantee signed by a CEO or sole proprietor can help ensure that you will be repaid. Requiring a personal guarantee can help protect you in the event that a client does go out of business.

It is worth your while also to consult with legal counsel to find out how you can protect your business in the event that you have to collect on a debt. Learning what you can do to protect yourself and being up-front about what you require in your terms can further mitigate your risk when it comes to collecting a debt.

Conduct Regular Reviews

When a customer has had credit with you for a while, reevaluating their credit line can be of benefit to you both. If they have been regular with their repayments and have paid on time, all the time, you may consider increasing the amount of credit. If they have been slow to repay, then reducing amount can help to protect you from potential issues.

Be sure you’re paying attention to your customers’ wants and needs. This can boost your sales, build stronger customer relationships, and protect your bottom line. Extending credit to those customers who you know that you can trust to pay you back is a solid strategy for success.

If you do your research, you can build better and stronger customer relationships (and increase your sales) without taking on a potentially damaging amount of risk. You don’t have to go through this process with blinders on. Be sure you have accurate information, set up a clear policy and do as much research as possible to protect yourself as you extend credit to new customers. A little precaution goes a long way, prevents costly mistakes, and it will make the risks you do take on that much more rewarding.

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