Customer credit is a great way to increase sales. If you are smart about how you grant your customers credit, you will be ahead of your competition. However, if you do not have a plan or if you have a plan and do not follow it diligently, your cash flow will suffer.
First and foremost, you need a contract with your customers.
Even an informal agreement such as an email with customer agreeing to your payment terms is better than nothing. If your customer is a business, a personal guarantee is important.
So how do you decide how to grant credit: to whom, how much, and for how long?
It is important to understand your customers, and how they pay.
There are 5 kinds of “payers”.
- Prompt and Regular – You never worry about payments. They pay on time. They deserve the most credit at the best terms.
- Slow but Steady – Usually long term customers who you count on for regular orders who have always paid, just slowly. They are usually 30-60 days behind, but are a good source of business. Grant them credit, but watch your outstanding balance. Set a maximum outstanding balance. Offer discounts for prompt payments. If they go beyond 90 days, get on the phone and speak to them.
- First Round Collection – These customers, when sent to a collection agency or attorney, pay voluntarily. They want to get back into your good graces. They need your product or service. Customers with seasonal needs often fall into this category. A fuel oil dealer client of ours saw a big rush of payments after the first frost. Require these clients clear up any old balance before you extend any more credit. After payment, require a deposit or convert them to a cash basis.
- Legal Collections – These collection clients will not pay without a legal action. Some will pay when they are sued. For other customers, you will have to obtain a court judgment against them, and then perhaps they will get religion and pay. For still others, you may have to resort to property liens, wage garnishments or other extreme measures. It should go without saying, but these customers should not only not have any credit with you, but should not be customers at all.
- Never Going to Pay – Customers who go out of business, have no assets to attach, or who file bankruptcy are almost always a lost cause. Look to see if there is any possibility to recover, but be prepared to walk away.
Customers may move from one group to another, and hopefully you are watching the aging of your receivables and will take the appropriate actions.
Customer credit is a privilege, not a right. Watch your customers, how they pay (or don’t pay), and cash flow will take care of itself.