Extending Credit: What You Need to Know

What Is Credit?

Credit is when you allow your customers to obtain merchandise or services before they pay for them. You are essentially trusting that they will pay you for them in the future. When customers use a credit card to make a payment, only the credit card company is assuming the risk. When you extend credit to your customer directly, you are assuming the risk. This means that if the customer does not pay, you take the loss.

Credit and Customer Relations

According to the Small Business Administration, the extension of credit by businesses is the single biggest source of small business lending in the country. One major benefit to extending credit is that it enhances customer relations and inspires customer loyalty. When your company offers credit, it shows that your business is stable, profitable and trustworthy. When a customer feels you have placed trust in them, they are more likely to give you repeat business, and you are able to generate more sales. Some people may be willing to spend more on credit than they would if they had to pay up front. Extending credit can also help bring in new customers because credit may appeal to some customers who want to conserve cash.

Risks of Extending Credit

When you extend credit to a customer, not only are you taking a risk that they will pay you, but it is also costing you money. You will need to make sure you have enough operating capital that not receiving payment for your goods or services right away will not affect your day-to-day business operations. If you run into a customer who does not pay back what they owe you, the process to try to recover your money can be long and tedious and may not always turn out in your favor. It may cost you additional money if you have to turn the matter over to a collection agency. In addition, extending credit requires extensive paperwork and excellent record keeping. If you will be doing your own invoicing, this can be tedious and time consuming.

Getting Started

It will be up to you to decide to which customers and businesses you want to extend credit. Running a credit check on them before extending credit is a good idea. You may not want to extend credit to someone who has a history of not making payments. You should have the customer fill out a detailed credit application so that you will have all of their information on file in case you end up needing to go after them for payment. Your business’ credit policy should be plainly spelled out in writing and a copy given to your customers. Any bill or invoice you send should clearly state when the payment is due and when it will be considered delinquent. Offering your customers options for payment, such as online payments or payment by phone, can help improve your chances of getting paid.

Legal Issues to Consider

If you decide to extend credit to your customers, it is important to learn about consumer protection laws. These laws govern things like how interest rates are advertised and how you can go about collecting debt, and they are enforced by the Federal Trade Commission. If a customer fails to make payment and you are able to get a judgment in court, it still may be difficult to actually collect what you are owed. If your customer declares bankruptcy, whether or not you get paid will be up to the bankruptcy court. This is why it is important to do a thorough evaluation before extending someone credit. You may want to contact your state’s consumer protection office to learn more about the regulations in your area.

Extending credit can be a great way to retain customers, increase sales and boost your company’s reputation. Understanding how it works, the risks associated with it and the laws that protect consumers can help you avoid extending credit to the wrong person and the need for long, drawn out collection battles.