In an ideal world, all your customers would pay promptly when they
receive your goods or services. Unfortunately, in reality this is not always
the case, but there are steps you can take to avoid late payment and bad debt.
The first step to getting credit management right is to establish a system of
credit checking customers before you hand over your product or service.
Cost factors
When credit checking a potential
customer, you should relate the depth (and cost) of the investigation to the
potential value of that customer. There is little point in spending all of your
potential profit on finding out whether the customer is likely to pay, for
these customers you should consider a policy of rejecting or accepting such
risks as a matter of course.
To conduct a credit check you can use an agency or, if you have the
time and manpower, you can do them yourself. To conduct a check yourself, you
should consider the following steps:
Ask the customer for a bank reference, but be aware that you
will have to pay for this and it can only be supplied with the customer's
permission
Ask for a couple of trading references, including a specific
question such as 'up to what level of trade credit is the customer considered a
good risk?'
Ask the customer for their latest report and accounts, or a
balance sheet and profit and loss account
Visit the business in person in order to meet the principals or
directors and verify its authenticity
Categories of risk
You can then use this
information to assess how risky you think a customer is and establish a credit
limit. A common system is to have five categories of risk, ranging from the top
category, which would be considered good for anything, to the bottom category,
which you will only sell to on cash terms. You can then draw up credit limits
and the number of days credit to apply to each category. These should relate to
the size of the debts relative to your sales and what is considered standard
practice in your industry.
