All business customers are not created equal. Even companies that look solid at first glance can hide festering problems that eventually can impact your bottom line. Successful credit management requires you to carefully evaluate the financial health of every business that asks for credit terms. Here are 5 questions you should be able to answer before extending business credit:
1. Is the business what it claims to be?
Sometimes, companies needing credit will provide inaccurate information to win approval. Before opening an account, you need to confirm the applicant‘s bona fides, including its location, size, number of employees, annual revenue, years of operation and similar financial indicators.
2. What is its payment history?
Although past performance does not guarantee future results, a company’s payment history is often a strong indicator of how it is likely to behave in the future. Pulling a business’ credit report can easily provide you a snapshot of a company’s payment history as well as other risk measures.
3. Are there hidden factors that could affect its ability to pay?
Are there pending judgments, lawsuits, bankruptcies, regulatory citations or other “red flags” that could make it difficult for the applicant to meet its obligations in the future? This is another area where a business’ credit report will be a key factor in helping you uncover a potentially risky business.
4. How much credit should you extend?
All credit contains an element of risk, but you can mitigate that risk by limiting the amount of credit you extend based on factors such as the customer’s sales volume, debt to-asset ratio and similar aspects.
5. Under what terms should you extend credit to this customer?
You can mitigate risk further by carefully calibrating the combination of interest rates, minimum payments and other contract terms based on each customer’s individual financial metrics.