In today's business world, offering credit has become common among companies of all sizes. It allows businesses to attract and retain customers, increase sales, and ultimately stay competitive in the market. However, extending credit also comes with risks that can harm a company's financial stability.
The dilemma for businesses then becomes finding the balance between offering credit to customers while minimising the risks involved. This is where effective credit management strategies come into play, as they can help businesses navigate this balancing act and ensure that their receivables are protected.
To understand how to effectively extend credit without risking receivables, this guide will cover the following topics:
- The importance of credit management
- Common risks associated with extending credit
- Strategies for minimising credit risks
- Tools and techniques for managing receivables effectively
By the end of this guide, businesses will have gained valuable insights and practical tips on maintaining a healthy balance between extending credit and protecting receivables. Let's dive into the details!
Point 1: Understand your customer's creditworthiness
The first step in effectively extending credit is understanding your customer's creditworthiness. This includes assessing their financial history, payment behaviour, and potential risks affecting their ability to pay.
Some ways to evaluate your customers' creditworthiness include conducting credit checks, requesting references from other businesses they have worked with, and analysing their financial statements.
Credit checks are a normal part of the onboarding process and can provide valuable information such as credit scores, payment patterns, and outstanding debts. This can help businesses make informed decisions about extending credit to a particular customer.
However, there's no reason to restrict credit checking to new customers. It's essential for businesses to regularly review the creditworthiness of existing customers as well, significantly if their payment behaviour changes over time.
Methods for credit checks
There are various methods businesses can use to conduct credit checks, including:
- Credit reports from credit bureaus: These agencies collect and maintain data on individuals' and businesses' credit history. Businesses can request a report on a particular customer to assess their creditworthiness.
- Trade references: Requesting references from other businesses that have worked with the customer in question is an effective way to understand their payment behaviour and creditworthiness.
- Financial statements: Examining a customer's financial statements can provide valuable insights into their financial health and potential risks they may face in the future.
Regularly conducting credit checks using these methods will help businesses stay on top of their customer's creditworthiness, allowing them to make informed decisions about extending credit.
Point 2: Set clear credit terms from the start
Credit terms are the foundation of a credit policy and significantly impact the risks involved in extending credit. It's crucial for businesses to establish clear and concise terms when offering credit to customers.
Any ambiguity in these terms can lead to confusion and disputes later, potentially harming the business's financial stability.
Some essential components of credit terms include:
- Payment due dates: Clearly stating when payment is expected from the customer will help them understand their obligations and encourage timely payments.
- Late payment penalties: Having penalties for late payments can discourage customers from delaying payment and reduce the risk of bad debt.
- Credit limits: Setting a credit limit for each customer can help control potential losses in case of non-payment or bankruptcy.
By setting clear and reasonable credit terms, businesses can effectively manage the risks of extending credit while maintaining a positive relationship with their customers.
Tips for creating clear credit terms
Here are a few tips businesses can keep in mind when creating credit terms:
- Use simple and easy-to-understand language.
- Avoid vague or ambiguous clauses that may lead to confusion.
- State consequences for non-compliance, such as late payments or exceeding credit limits.
- Include as much detail as possible, such as payment methods and accepted currencies.
By following these tips, businesses can establish clear credit terms that benefit both parties.
Point 3: Offer tiered credit limits
A one-size-fits-all solution is rarely effective when it comes to extending credit. Businesses must consider different customers' varying financial situations and offer tiered credit limits accordingly.
For example, a customer with a strong payment history and stable financials may be eligible for a higher credit limit than a new customer with no prior history. This approach allows businesses to minimise risks while offering competitive credit terms.
Businesses can also periodically review and adjust these credit limits based on the customer's payment behaviour. This ensures that the limit remains appropriate and reduces the chances of bad debt.
There are several benefits to offering tiered credit limits, including:
- Reduced risk of bad debt: By setting varying credit limits for different customers, businesses can minimise the overall risks of extending credit.
- Improved customer relationships: Customers may perceive tiered credit limits as a sign of trust and value, potentially leading to more substantial long-term relationships.
- Better cash flow management: By offering appropriate credit limits, businesses can ensure a consistent cash flow while minimising the risk of delayed or non-payments.
These benefits make tiered credit limits valuable for businesses looking to extend credit while protecting their receivables.
Strategies for setting and reviewing credit limit tiers
To effectively set and review credit limit tiers, businesses can consider the following strategies:
- Conducting regular credit checks to assess each customer's creditworthiness.
- Setting a maximum percentage of total sales can be extended as a credit to all customers combined.
- Continuously monitoring payment behaviour and adjusting limits accordingly.
- Communicating any changes in credit limits clearly and promptly to customers.
By following these strategies, businesses can effectively manage and adjust their credit limit tiers to minimise risks and maintain healthy customer relationships.
Point 4: Stay proactive with invoicing and follow-ups
A proactive approach to invoicing and follow-ups can significantly reduce the risks of extending credit. Timely invoicing and regular follow-ups encourage customers to make timely payments, minimising the chances of delayed or non-payments.
Businesses can also consider setting up automated reminders for overdue invoices to remind customers of their payment obligations. This approach saves time and effort while ensuring businesses stay on top of their receivables.
Furthermore, consistently following up with customers regarding late payments shows a commitment to managing credit responsibly and can improve customer relationships.
While taking a proactive approach makes a huge difference, it can be time-consuming and labour-intensive. That's where credit management software comes in, automating the entire process for businesses and ensuring efficient credit control.
Chaser's credit management software offers features such as:
- Automated invoice reminders and follow-ups.
- Customisable templates for invoices and reminder emails.
- Detailed reports on customer payment behaviour.
- Integration with accounting software for seamless credit management.
With Chaser's credit management software, businesses can streamline their invoicing and follow-up process, freeing time to focus on other critical tasks while ensuring proactive credit control.
Best practices for invoicing and follow-ups
Here are a few best practices businesses can follow for effective invoicing and follow-ups:
- Send invoices as soon as possible: Sending invoices promptly ensures customers have enough time to make payments within the agreed-upon terms.
- Set up automated reminders: Automated payment reminders can save time and reduce the chances of forgetting to follow up on overdue payments.
- Be persistent but polite: Consistently following up with customers is essential, but it's crucial to maintain a professional and courteous tone in all communications.
By implementing these best practices, businesses can stay proactive with invoicing and follow-ups, reducing the risks of extending credit while maintaining healthy customer relationships.
Extending credit can be a beneficial strategy for businesses looking to grow and attract customers. However, it's crucial to establish clear credit terms, offer tiered credit limits, and stay proactive with invoicing and follow-ups to minimise the risks involved.
By following these strategies and best practices, businesses can effectively manage their receivables while maintaining positive customer relationships, ultimately achieving the balancing act of extending credit without risking receivables.
Businesses should carefully consider these factors when establishing a credit policy and continuously review and adapt it to ensure its effectiveness. Further research and analysis of customers' payment behaviour can also help businesses make informed decisions about extending credit to minimise risks.
With proper management and careful consideration, extending credit can be a valuable tool for businesses to drive growth and build strong customer relationships.
For more information on how Chaser can help your business with credit control and receivables management, request a demo with one of our experts or start your no-obligation 14-day free trial today.