Customer Creditworthiness: Why It Matters for Your Small Business

If your small business is like most companies, credit risk may come with the territory. In many industries, customers expect to be granted payment terms; that is, the leeway to pay for goods/services at a point following delivery (typically 15, 30 or 60 days). While common-practice from a customer’s perspective, granting long-terms means exposing your business to the risk it will not be paid at all.

In the event that a customer fails to meet their financial obligations, it will negatively impact your business’ cash flow. The worst-case scenario involves your business experiencing multiple customers who are similarly negligent. Not only will this situation quickly place your business in a dangerous cash flow position, it could also result in having to lay off staff, halt plans to expand or – every entrepreneur’s nightmare – force you to close your doors.

Mitigating the Risk to Your Business

To avoid this, you should slowly and carefully build a credit relationship with your customers. The best way to do this is to approach credit on a case-by-case basis. The first step in this process is to structure and establish a formal credit policy that details clear and specific conditions under which you will grant payment terms to customers. This policy should include your credit-evaluation criteria, how much credit you are willing to extend, your payment terms (e.g. net 60 days) and penalties and interest that will accrue on late payments.

Our invoice factoring company recommends the following steps or actions to help you effectively monitor your customer’s creditworthiness, while also reducing the risks for your small business.

Credit Application

It’s crucial that you create a complete credit application that includes basic information: address, contact information, references from other businesses (who have extended credit to the customer), tax ID, etc. It’s also important to request details about the customer’s payment history. If payments were late, how late were they? Did the customer try to communicate openly? Did they take steps to arrange a payment plan? That being said, make sure you are aware of any credit arrangements, since they have the potential to affect whether they can pay you.

Credit Reports

Obtaining a potential customer’s credit report is always a good idea before extending credit. This report will provide you with historical payment data, liens and court judgements against the company, bankruptcy records and any lawsuits. You will also be provided with a risk rating that predicts how likely that customer is to pay their bills. If the potential customer has little to no credit history, it is still worthwhile to secure a credit report as it will still reveal relevant data (e.g. corporate records, bankruptcy filings, tax liens, fictitious business name filings, etc.). Credit reports can be obtained through credit reporting agencies. Some agencies will even provide the report online. If you’re requesting multiple reports, you might be able to sign a contract that reduces your per-report price.

Credit References

You can also go a step further and check a customer’s credit references. Keep in mind that, while informative, they are not completely foolproof (customers pick their references). To ensure you receive a realistic picture, request a comprehensive list of suppliers, and ask if the customer owes them money. If so, have they been making timely payments? It might also be beneficial to inquire after the customer’s relationship with their banker. How long has the bank had a relationship with the customer? Is the customer known for meeting its obligations?

Financial Statements

If your customer is a public company, its financial statements will reveal a lot about the company’s ability to repay you. A good indicator is the ratio of the company’s current assets to its current liabilities. On the other hand, if the business is a closely held private company, you might not be able to obtain its financial statements, but could request credit references.

Public Information

Often overlooked, the news release section on a business’ website is a great tool for determining whether there are any issues that might affect its ability to pay. You can also find useful information through a simple search engine exploration. If the customer is a publicly traded company, it is required that fact-filled reports are filed with the Securities and Exchange Commission (SEC) concerning the current state of the business. When it comes to checking a prospective customer’s creditworthiness, it never hurts to use every method at your disposal.

How Invoice Factoring Can Help

Managing cash flow and monitoring customer’s creditworthiness can be an overwhelming balancing act for the small business owner or startup. Invoice factoring provides a solution for both these issues. The invoice factoring process involves the factoring company purchasing your business’ invoices, and then quickly advancing the working capital your business needs against its unpaid accounts receivable.  Essentially, unpaid accounts receivable represents a successful sale that your business has yet to receive payment for. Since accounts receivable are the lifeblood of your business’ cash flow, mismanagement can quickly push your business into a dangerous cash flow situation.  

Because invoice factoring is not a loan, your business can avoid a burden of debt. It simply allows you to receive cash for goods and/or services your business has already provided, instead of waiting for your customers to pay their invoices. In addition, your business is not required to factor all invoices or every customer. Your business can choose which credit approved customers they wish to factor, as well as which invoices they want to factor from those customers.

In regards to your customers creditworthiness, Security Business Capital (SBC) provides this service as part of its back office support. SBC will run the necessary credit reports, references, etc. on your customers in order to establish a credit line and help you make sound credit decisions. As always, you will have the best relationship with your customers; however, SBC will come alongside you as a partner to help determine their credit worthiness. Ultimately, this cash flow solution helps your business scale – as your business grows, so does its funding capability.

Security Business Capital specializes in helping companies secure the funds they need to operate smoothly, grow their business and take advantage of opportunities. SBC’s invoice factoring services provide the flexibility a rapidly growing business needs to prosper. If your startup or small business is seeking alternative financing solutions to meet expenses or fund expansion, consider what Security Business Capital’s invoice factoring services can offer your business. Oil and gas services, temp staffing, manufacturing/distribution and transportation are just a few of the business types that can use SBC’s invoice factoring services to generate cash on hand. With SBC, there are no hidden fees, no closing costs and no origination fees; just one, low rate that is clearly explained and covers all our services.

To learn more about Security Business Capital’s invoice factoring option (or our other service options), contact us for a free quote and/or consultation.