Setting Up Payment and Credit Policies

You’re going to find that the process of extending credit is one of the most onerous aspects of running a business. If you can get away with being paid up front, or on delivery, by all means do it! If you can’t get total payment up front, then maybe you can get partial payment in advance and additional payments as work progresses.

You will generally be able to get away with requiring immediate payment if you provide products or services to consumers. Accepting credit cards will help, and many of your customers will perceive this as a convenience. Credit card fees may run as high as 5 percent (I would shop around before paying this much), but accepting them will speed your cash flow and save the time and effort involved in billing and collection procedures. It also cuts down on bad debt.

In almost all types of business-to-business transactions, you will be expected to extend credit in order to close the sale. In some industries it is standard to require a percentage of the sale up front, especially if the client is new or the business is a start-up.

Budding entrepreneurs have a remarkable tendency to overlook the importance of carefully extending credit and aggressively collecting on overdue accounts receivable. Collection activities tend to begin in earnest only when cash flow is negative. Don’t overlook this important aspect of running a business. Get good people and sound policies in place as soon as possible!

Credit Policies

You need to establish credit policies before orders start coming in. You need to inform customers up front if orders exceed their limits so that they can either prepay the credit overage before shipment or scale their orders back.

The percentage of fraudulent orders (orders placed with no plans to pay for the goods received) placed in business is statistically insignificant. But many businesses of all sizes are constantly running into cash flow binds, and are forced to pay their own bills well after they are actually due. Furthermore, many companies of all sizes pay their bills slowly, even when they have plenty of cash, just as a matter of policy. If you are a new, small supplier you will probably be the last in line to get paid.

As soon as you open an account or get an order, you need to run a credit check on the customer. When accepting orders from large companies, request confirmation in writing via a purchase order. One of the best ways to get paid on old invoices is to insist that an account be brought up-to-date before new orders are processed or shipped.

The best indicator of a client’s intentions and ability to pay a new debt can be found by reviewing past payment patterns. However, if you are a new or smaller supplier, you may not have a recent payment history for some or even any of your clients. In this case, you should make reference checks before extending credit terms. Ideally, you should develop contacts with credit departments at similar-size firms in your industry. You can exchange credit information with these contacts.

You cannot unilaterally deny credit to a client on the basis of your credit contacts, as this could put you at risk for legal action, but you can share factual information. As a second choice, you can request credit references from the client; as a third choice, you can purchase credit reports from commercial credit-reporting services.

There are other more sophisticated methods for analyzing credit. Generally, however, current payment patterns provide the best and easiest indicator.

About Bob Adams

Bob Adams is a Harvard MBA serial entrepreneur. He has started over a dozen businesses including one that he launched with $1500 and sold for $40 million. He has written 17 books and created 52 online courses for entrepreneurs. Bob also founded BusinessTown, the go-to learning platform for starting and running a business.