In Part I of this article, we examined the differences between Chapter 11 and Chapter 7 Bankruptcy. In Part II, we will review some best practices for managing credit exposure risk.
If your business sells or ships goods without prepayment, there is a risk that you will not get paid. Yet, granting credit on net terms to trusted customers is an important part of doing business. Sometimes when customers don’t pay, and the amount due doesn’t warrant the expense of legal action. However, there are many things you can do to limit your risks as part of your everyday business practices.
Some Customers are More Credit Worthy than Others
If you have been doing business with a customer for a period of time, then you probably already have a good sense about their payment patterns.
- Customers who have always paid on time are more likely to continue to pay on time.
- Customers who pay late repeatedly are more likely to pay late in the future.
- Customers who defaulted on payments in past should not be shipped without some form of prepayment.
When opening an account with a new customer (ASTRA members: download a New Account Information sheet here) there are several things you can do to minimize credit risk:
- Check credit references. This is, by far, the best way to ascertain a company’s credit worthiness. Most credit-worthy customers will happily provide a list of companies they are doing business with. Ideally, these should be in the toy/gift industry, but additional references outside the industry can also be used. When you get references, check them! You can make it easy for new customers to provide the exact information you require by creating a Credit Application for them to fill out and return. (ASTRA members: download a Credit Inquiry form here.)
- The smell test. Maybe not the most appropriate name, but here you should consider non-financial factors: How long has the company been in business? How many employees does it have? Does it have a physical storefront that you can verify with Google Street View? Does the order size seem reasonable based on all information you have? How did you get the order? (Was it from a through a trusted sales rep or was it unsolicited?) Check crowd-sourced review sites, such as Yelp for reviews. Many of these questions can be part of your Credit Application.
- Obtain a credit report. There are numerous credit reporting agencies that will be thrilled to sell you a credit report on a business: Dun & Bradstreet, Equifax, Cortera, Credit.net, just to name a few. Be aware though that much of the information from these sources are self-reported.
- Is the customer publicly-owned? If so, check their recent SEC filings. Remember, just because a company is public does not automatically mean it pays well.
Work with your customers to develop trust.
- Request prepayment for the first several orders and gradually grant terms to build up a history, making sure you keep to a credit limit that works for your business.
- If you accept credit cards as payment before shipment, make sure to process the charge before you ship the order. Just having the number doesn’t mean the charges will go through.
- The same goes for a check. Cash the check and make sure it clears before you ship the order.
If you do decide to extend terms, set some basic policies.
- Set a limit on the amount of credit you’re willing to extend to the customer and never extend more than you can “afford” to lose.
- Collect payment on outstanding orders before shipping any new orders. Even if you’re extending “small” amounts of credit, if you settle up outstanding balances before shipping new orders, you can prevent accidentally overextending on any given customer.
Negotiate terms that work for your business.
- Consider a combination of prepayment and terms. Perhaps you require 30% down with the 70% balance Net 30. For custom or special-order merchandise, you might have to insist upon this.
- Consider the entire “deal”, not just the dating on the order. For example, you might decide to offer a discount instead of terms. For example: 10% discount with prepayment. Or 5% discount and Net 30 instead of Net 90 on the remaining balance.
For Larger Orders Consider Credit Insurance
If you are extending credit for larger shipments, for exampe over $15,000, you might want to consider credit insurance. There are a few insurers that offer credit insurance; Coface and Euler Hermes are both well-known providers. Do your homework, though, since credit insurance can be very expensive and may not cover all your sales. Also, most insurers have a deductible which must be met before the insurance kicks in.
Credit Insurance and International Customers
Credit insurance is very useful with foreign accounts. Your bank probably doesn’t permit loan advances made to foreign companies. However, if you have credit insurance, your bank may let you use that receivable as collateral.
Letters of Credit
A Letter of Credit (“LC”) is a document from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. As long as you can prove you sent merchandisable goods, you will be able to collect from the bank if the customer does not pay as detailed on the LC.
- Only companies with enough free collateral to cover amount of the LC are generally able to have their bank issue one on their behalf.
- There are fees associated with LC’s and there documentation must be precise and this can be a bit time consuming.
- Be aware, though that all LCs are not created equal. There are many types, including Revocable, Irrevocable, Transferable, and Standby LC’s. Knowing which type of LC is appropriate for your situation is a matter for your attorney to determine.
By implementing everyday business practices to manage your credit exposure risk, your business will be best prepared to withstand the volatility of the fast changing business environment of today.
This article is intended to provide a general overview and is for informational purposes only. It is not financial or legal advice. You should contact appropriate legal and finance professional(s) to obtain advice with respect to any particular issue or problem.
Dee has been a successful Sales & Marketing executive for the past 30 years in big and small companies and most recently was the Senior Vice President of Neat-Oh! International.
Before Neat-Oh!, she was Director in the Office of President at a global enterprise software vendor where she was responsible for corporate strategy initiatives and measuring the company’s sales and marketing performance. Throughout the years, she built trusted relationships with retailers of all sizes. As a member of the ASTRA Board of Directors, Dee contributes to finding innovative ways in which all small businesses can successfully navigate the rapidly-changing way consumers look for and buy toys.
Dee holds an MBA from the Kellogg School of Management at Northwestern University and a Bachelor of Music Performance from Northwestern University in Evanston, Illinois.