Granting Credit to a Customer
The small business operator must realize that granting credit will be, and should be, one of their major concerns. Poor credit and collection policies have resulted in the failure of many companies, so it is very important to establish credit policies at startup. These policies will have an influence on the financial, marketing, and sales/service planning, and will help to determine whether to deal in cash, credit or a combination of both.
There is no set credit procedure which will fit every business. The choice will depend upon a host of situations: the particular industry you are in; the customer and the likelihood that you will be paid in a timely manner; your competition; national and local economical conditions; your own financial status; and finally, the affordable risks you can and are willing to take.
When planning the opening of your business you should put into place written general credit-granting guidelines which can be applied to best fit the customer and your own circumstances, with variances which can be used as necessary to fit case -by-case situations. Will you accept checks or credit cards? Will you accept cash only and/or credit, c.o.d? Will you expect written contracts, collateral, promissory notes? What payment terms will apply to your billings? What procedures will you use to collect delinquent accounts?
When granting credit to a customer, the owner is actually financing that purchase, be it services or products. There are two elements of the transaction that should be considered:
What is the impact on the cash flow or financial needs of the company?
- Credit granted to customers is shown as "accounts receivable" on the balance sheet. This must be monitored on a regular basis. It is important that collection contacts be made in a regular and disciplined pattern so that accounts that are not paid in a timely manner will be approached for payment.
- According to research data that track the successes and failures of new businesses, many failures are the result of a lack of operating cash to support the needs of the company operations. The demands for cash will differ due to the type of business; however, timely payment of bills is necessary to keep solvent. Closing sales without receiving a cash payment does not give the owner the resources to replace inventory, pay wages, or cover other expenses.
- In the event that the company is operating on borrowed funds, it is necessary to consider the cost of the interest on carrying the debt. The customer has an interest-free loan for a period of time, while the business owner is paying interest on a loan that might be reduced if it were not for a sale without cash payment.
- What precautions should be taken in granting credit to a person or business to assure that the credit or loan amount is paid or collected?
- Don't be naive in thinking that everyone who seeks your product/service is creditworthy. You should take steps to separate the good from the marginal and the outright bad risks. Guidance information can be secured from a credit bureau, a business that collects and dispenses credit histories of customers, and/or from your area Better Business Bureau. You may need a contract with a credit bureau in order to have access to its information.
- Consider these credit procedures. When opening an account or obtaining an order, run a credit check on the customer. You can order a report from Dun and Bradstreet online at http://www.dnb.com/us/ . There is a charge for these reports from $59.55 to $149.00 depending on the amount of detail requested. D&B’s business credit reports can help you determine whether or not to extend credit to a company; establish proper credit terms; and gain insight into prospects, customers, suppliers and competitors.
- When accepting a large company order, ask for confirmation in writing via purchase order. If warranted, insist an account be brought up to date before any new orders are processed or shipped. Stipulating upfront payments (e.g. one-fourth, one-third, one-half) of the sales amount or scheduling balance due to be paid in regular installments may forestall concerns about questionable credit seekers. You should consider setting a credit limit, say $400.00. Any larger amount requires a credit application. SCORE Brief 4.33 is a sample credit application. Brief 4.35 includes information as to how to use the application and on collection procedures.
- Collection work is difficult, and a certain amount of mental toughness is necessary to do the task. It can be time-consuming for you to do yourself. In the event that payments are not made on time and become seriously delinquent, you may have to seek professional help. However, be aware that a collection agency may charge one-third of the amount collected. The cost of going to a small claims court is not excessive, but by going that route you can lose a significant amount of time that could be used for other productive efforts.
- Whatever method you use to collect, be sure that you follow carefully the established legal and ethical guidelines for the collection of debts. See the Federal Trade Commission’s “The Fair Debt Collection Practices Act” at www.ftc.gov/bcp/edu/pubs/consumer/credit/cre27.pdf as well as state laws/regulations involving deceptive or unfair collection methods).
Local banks are interested in building their credit card business. Talk with your banker about setting up a credit card relationship. The cost to set up a program currently is about $100, which includes the necessary supplies. Be aware that the major cost is the charge for each transaction, which, depending upon the volume may run as high as 6% of the sale. However, this expense should be weighed favorably against the potential for additional sales and the fact that the credit card supplier advances you cash almost immediately and assumes much of the credit risk. This can have a very beneficial effect on your operating expenses and cash flow. There is no need to allow for losses on bad debts, nor for you to worry about the time spent working on collections, hence more time is available for focusing on the main purpose of your business. In your credit planning, do not overlook the importance of pricing services and/or products to cover the credit card charge.
Be aware that you may receive a charge back for a credit card transaction. A cardholder may dispute a charge for many reasons (see below). The cardholder is within his/her legal rights to begin procedures to dispute the charge up to six months after the date of sale, although in some cases the charge may be disputed up to 3 years after.
Am I Liable for Chargebacks?
Yes, if the customer has a valid dispute with the charge in question and you do not satisfactorily remedy the situation. If, however, the customer doesn’t have a valid dispute and you complied with processing regulations, you may not be liable.
What are some of the Different Types of Chargebacks?
A sale can be charged back for more that 35 valid reasons, the four most common are:
no signature on a draft
failure to fulfill a request for a sales draft
no imprint on a draft
There are numerous guidance books on credit and collection techniques available in the Government & Business Department, main Public Library of Cincinnati and Hamilton County, 800 Vine St., downtown Cincinnati. Another very good source is the Dayton Metro Library, 215 East Third St. Dayton, Ohio 45402
See Brief 4.33 for a sample credit application
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