Q: Should I always investigate the credit worthiness of potential customers?
Jan 07 2010
Answered by: Marc Barber Ask a question
Few businesses can confine their sales to completely ‘safe’ customers who are guaranteed to pay what they owe and on time; usually, an element of risk is needed to meet your business objectives. But the riskiness or otherwise of customers needs to be assessed so that the risk is known and calculated. Assessment needs information, control and monitoring.
The extent of the investigation must also depend on the amount of the projected sale relative to your total sales. If it is a fairly small sale, the investigation alone may cost as much as the profit from the sale; you should establish a policy of rejecting or accepting such risks as a matter of course. But if the sale would be a significant order for your, further information is needed.
Consider the following steps:
• if you are dealing with a large quoted company, check its payment policy. This must be published in its annual report and accounts. Since November 1998, small businesses have by law been able to claim interest for late payments from large businesses and public sector bodies. (This right has now been extended under European legislation to businesses of all sizes.) However, surveys suggest that small businesses seldom use this right, possibly because they cannot afford to lose future business from a client as a result of a payment dispute. To find out more about your right to charge interest and the amount you can charge, see The Better Payment Practice Campaign. An advantage of bidding for government contracts is that all central government departments have signed up to a prompt payment initiative – by March 2009, 90 per cent of its payments were made within ten days.
• ask the prospective customer for a bank reference (but this will be based only on the bank’s experience, so it may indicate relatively little, but it will help in building a general picture).
• ask for a couple of trade references. Put a specific question such as ‘Up to what level of trade credit is the customer considered a good risk?’
• ask a credit reference agency to report
• ask the customer for the latest report and accounts or a balance sheet and profit and loss account. Ask your accountant to analyse them for you.
• if you have not already done so, visit the business with a view to meeting the principals or directors. Put any questions that remain unanswered and use this visit to fill in the general picture.
• using the information you have garnered from all these sources, assess how risky you think this customer is and establish a credit limit. A common system is to have five categories of risk, ranging from the top category, who would be considered good for anything, to the bottom category, who you would sell to only on cash terms. You could draw up certain credit limits to apply to each category, for example allowed £1,000 on 30 days’ credit. The actual amounts would depend on the size of debts relative to your sales and what is considered normal practice in that industry.
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