Customers are your bread and butter, but they can also be your biggest risk. Now more than ever, small businesses need to take a page from some of the world’s largest companies to reduce exposure to “bad” customers.Tweet This Establishing a consistent credit policy and monitoring your business partners’ credit files can help spot potential issues—or new opportunities—that you should know about.

This brief outlines steps you can take to establish and apply a credit policy that works for your small business, including:

  • 3 steps to building a credit policy
  • Signs that something is changing—for better or worse—with a customer
  • How to evaluate information sources to be sure you’re getting all you need

Business Credit Policies: Reducing Risk, Strengthening Cash Flow & Giving You Peace of Mind

There’s a lot that keeps the small business owner awake at night. Can I meet payroll? Can I perform necessary maintenance on my equipment or facility? What’s my competition doing? How can I innovate? Will this be the year I finally turn a profit? The list goes on and on.

The best possible answer to all of the questions is financial well-being, which includes new customers, expanded opportunities with existing customers, and getting paid on time, all the time.

Credit policies can go a long way to ensuring stable and predictable cash flow. You don’t have to be a trained risk or credit specialist, and your policy doesn’t have to be intricate and complex—but you do need to have one.

Here are 3 steps you can take to build a credit policy that works for your organization.

1. Determine How Much Credit You Can Afford to Extend

The first step in establishing a credit policy is to understand how much credit you can afford to extend. With just a little thought you can create a framework that’s grounded in the deep knowledge you have about your business, your own tolerance for risk, and your experience with customers and payments.

Start by defining:

  • the standard set of information you will collect in order to understand your customers’ capabilities and assess their willingness to pay.
  • what steps you will take if they don’t supply that information.
  • the maximum line of credit you will extend to any customer.
  • how long you will allow for payment, what early payment discounts you’ll offer, or whether to offer them at all.
  • clear penalties for late payments.

Setting customer credit limits should be determined on a case-by-case basis, as you need to understand the details of how their business has been performing in order to manage your risk.

You might also consider delegating the task of evaluating a credit application to someone in the organization that you trust (you might just be too close to the issue to be truly objective).

2. Business Information: “Trust, but Verify”

Small business success is built on relationships. At the heart of every entrepreneur is an optimist who sees almost any business opportunity as a means to further success. More often than not, they find it hard to say “no” when a sales opportunity comes through the door. It makes sense, of course. Signing a new customer means more revenue, which means new capital to put to work—meeting payroll, paying suppliers, and maybe even expanding with a new hire, a new site, or a new piece of equipment.

But more often than anyone would care to admit, the potential and promise fall short of the reality.

Beyond the handshake, you need to know, and confirm, important business details. These include:

  • Who is on the management team?
  • How long has the management team been in place?
  • Who are some of the company’s current customers? How balanced is the company’s customer portfolio?
  • Who are some of the company’s suppliers?
  • What’s the firm’s payment history? Does it have a collection of trade references**?
  • How are the business’s credit scores and ratings?
  • How long has the firm been with its bank?
  • Are there are any outstanding lawsuit, liens, or judgements against the company?
  • Are there any corporate family relationships that mean this prospect is part of a larger, profitable organization?

Small business owners need to trust their instincts, but back it up with cold, hard data that can help reduce customer risk. With a deeper data set on prospects, you’ll be in a much better position to manage the relationship for financial stability, and be confident in your decisions.

Creating a Business Credit Application for Your Company

Before running a business credit check, you can ask the potential customer to provide information on their company. Collecting most—if not all—of the information here will give you a much more complete picture of a credit applicant:

  • Full legal name and address for the business
  • Date of founding
  • The form/type of business
  • The company’s bank
  • A listing of the applicant’s suppliers (to gather trade references)
  • Profit-and-loss statement from the last fiscal year
  • A list of current assets, including inventory, cash on hand, accounts/notes receivable, buildings, land, fixtures, and equipment
  • A list of current liabilities, including accounts/notes payable, accrued taxes, payroll accrued, and long-term liabilities
  • Total net worth
  • Value of machinery or equipment held under lease
  • Most recent audit and dates of latest inventory count
  • Dollar totals of insurance, including liability, fire, etc.

Beware of the Google Trap

Online search and social networking sites have been a boon to small business owners. With access to company profiles at the click of the mouse, many small business owners rely on Google, LinkedIn, and other online sources to review a prospect. They often search for evidence that the company is legitimate, along with possible connections that can provide back-door references.

It’s important to recognize that while you might be able to confirm basic information about a business, the details available in search are widely self-supplied or influenced by marketing. While enough to establish a baseline, the information gained through online search is just the tip of the iceberg when it comes to getting the data you need to make the best possible business credit decisions.

3. Make it Possible to Always Say “Yes”

In lean times, it may simply seem impossible to say “no” to a prospective customer. The good news is that a thoughtful credit policy may make it easier to say “yes” more often. Marginal customers may have potential; the key is to provide yourself with a clear-headed assessment of the risk involved with each business.

Managing Marginal Customers

Almost every customer has potential. You need to recognize which opportunities come with risk, and then use strategies to limit your exposure, including:

  • Require progress payments to mitigate part of the risk
  • Limit exposure by shipping only one order at a time
  • Employ security instruments such as deposits, guarantees, Letters of Credit, or Uniform Commercial Code filings

Business Conditions Evolve. Your Credit Strategy Needs To, As Well

It’s easy enough to sign a customer, set reasonable credit terms, and then never take the time review their payment history and re-evaluate the line of credit you’ve extended.

Customers are just like you; when times are good, their business grows. This gives you an opportunity to sell more and expand your relationship with them. When times are tough, there are often signs that point to a financially stressed business. Learning to recognize these signals is an important part of managing credit risk.

Take Note of These Business Behaviors

Not all signs of change in a customer’s credibility are as obvious as late payments. Knowing what to watch out for can make a real difference in how quickly your own business grows.

Event Good News Bad News
You’re paid on an accelerated timeline You can put that money to work much more quickly. Even better, the customer may be thriving, giving you an opportunity to expand your business with them. If you’re critical to the customer’s ability to do business, on-time or early payments may actually indicate that the company is struggling to do everything possible to keep the doors open, or raise their credit profile in advance of seeking a loan.
Change in location/ real estate transaction The customer’s business may be booming and they’ve expanded; a good time to see how you might be able to help them do more. It might be that they’ve had to downsize and you need to get in line first to ensure your account is settled.
Change in a banking relationship The customer may have found a lender more enthusiastic about their potential. Maybe you should, too. The existing banking partner may have ended the relationship due to higher risk.
Change in leadership There may be some new leadership with an expanded vision, and an ambitious plan for growth—the perfect time for you to demonstrate the value you can deliver now and in the long term. The company’s board may have decided that it’s time to end all old relationships (including the one with you).

It’s important to watch for changes that have the potential to impact your business, and to establish a regular review of the financial aspects of the relationship. When changes occur, the simplest course of action is to pick up the phone and speak to the customer about what’s happening. You can also do some digging on your own or engage a service that specializes in investigating businesses.

Choosing a Business Credit Research Partner

A business credit bureau such as Dun & Bradstreet can be a small business owner’s best ally in helping protect all you’ve built from a cash flow crisis. Maybe you do a credit check when first engaging with a prospect, but as has been shared here, there’s a great deal more information you can use to fuel decision making.

When evaluating a resource for credit information, you need to consider these factors:

Data integrity: Where does it come from? What processes and requirements does the provider have in place to validate the information?

Data breadth and depth: How many sources of trade payment behavior does the provider use in developing the customer profile?

Customer-centricity: How flexible is the provider in terms of working with you as a small business?

Choosing the right business information partner means you’ll get the insight and intelligence you need to make smarter credit decisions. More importantly, you’ll be taking proactive steps to shield your business from the risks associated with bad debt. Dun & Bradstreet offers a variety of business credit tools for companies of almost any size.

A Brighter Future for Small Businesses

Establishing a credit policy that evaluates another business’s ability to pay for your goods and services can be incredibly beneficial for any company looking to thrive in today’s volatile economy. With sound credit policies in place, you may see:

  • Larger sales volume: customers may buy more at the outset if they know they can pay over time.
  • More sales from existing customers: when you know which customers are good financial partners, you have a clearer view of which customers you should invest more time with to win more of their business.
  • New customers: credit terms may entice customers who hadn’t done business with you to try your goods or services.
  • Competitive advantage: you may be able to take a greater share of the market with terms that are more attractive than a competitor.

With the right safeguards in place, small business owners can focus on what’s best about being an entrepreneur: hiring new employees, expanding operations, finding new partners, developing and delivering innovative products and services, and delighting customers.

About D&B and Small Businesses

D&B’s global commercial database and solutions provide small businesses with the tools and resources needed to succeed. Small businesses have relied on D&B for 172 years to help build and monitor their business credit and to confidently make business-impacting decisions. For more information about D&B’s solutions for small businesses, visit our website or call us at 1-800-701-7168.

Photo Credit: BeatriceL, Twenty20