One of the biggest challenges of working with commercial clients is that they often buy products and services on credit terms that give them 30 to 60 days to pay an invoice. Unfortunately, there is little room for negotiation about offering terms. Most large companies demand terms and write them into their boilerplate contracts. And if your company does not provide terms, the client will find a vendor that does.
Dealing with terms puts you, as a small business owner, at a financial disadvantage. First, you have to accept the risk that the client may pay late – or never. Second, you must contend with the financial implications of waiting to get paid. Obviously, running out of money creates a serious problem, so you need to have enough money on hand to cover expenses.
Giving credit can be good – if done right
Most business owners dislike giving credit. It’s understandable, and it’s obvious that getting paid immediately is better. The problem is that you seldom have a choice. As said before, large clients demand credit terms. Since you can’t avoid having to offer credit, your best bet is to use credit strategically.
You can use credit as a tool for growth by offering it selectively and strategically, as an advantage, to your best clients and by declining it to those who may not pay. The problem is that few small business owners know how to recognize a good payer beforehand.
For example, just because a client is a large corporation doesn’t mean that they will pay on time. Many large corporations are lousy payers. The opposite is also true:a small client is not necessarily a bad credit risk; some are great payers.So, how do you tell the good payers from the bad payers?
How to give commercial credit – the right way
Let’s start by saying that no credit review process is perfect. However, you can minimize the chances of having problems by following a few simple rules of thumb.
The cardinal rule of credit is that your client usually treats you as well as they treat other vendors. In other words, if they pay other vendors on time you can be reasonably certain they will pay you on time. You can get this information on a commercial credit report from companies like Dun and Bradstreet, Cortera, and others.
Credit reports show your client’s payment history: how well they pay other vendors. Reports also include important information such as the number of open lines, maximum credit, judgments, and payment trends. Payment trends are significant because they warn you if a client is paying invoices slower than it did in the past. This trend often indicates financial distress.
Reports also provide estimated credit limits. Take these credit limits as suggestions, rather than as requirements.You usually want to offer the client a credit limit that is close to the average of what other vendors provide.
One last point: use your own judgment. A report can provide you with information but cannot make a decision for you. In the end, it’s you– the business owner– who must decide whether the risk of offering terms is worth the reward of winning a contract.
Avoiding financial problems
One of the greatest challenges of providing credit terms is that you could run out of money while waiting for clients to pay invoices. This scenario is common for new companies and small businesses that are growing quickly. It could have serious consequences for your business. Unfortunately, financial problems tend to spiral out of control unless they are handled properly.
Build a cash reserve to cover expenses for a while in case there are unforeseen delays. A reserve isn’t always sufficient, though. It’s easy to exhaust a reserve, especially if you win a large contract.
If your business is growing quickly, consider external financing such as a loan or line of credit. If a business loan is not an option,consider financing your invoices through a factoring program. While more expensive than loans, these programs can help small companies that have cash flow problems because clients are paying slowly.
One last point: review your cash flow statements and bank account regularly to help ensure that problems don’t catch you by surprise – when they are too late to fix.
Marco Terry is the managing director of Commercial Capital LLC, a leading provider of invoice factoring and purchase order financing in the US and Canada.
Image courtesy quaziefoto