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Credit check a potential customer

In an ideal world, all your customers would pay promptly when they receive your goods or services. Unfortunately, in reality this is not always the case, but there are steps you can take to avoid late payment and bad debt. The first step to getting credit management right is to establish a system of credit checking customers before you hand over your product or service.

Cost factors

When credit checking a potential customer, you should relate the depth (and cost) of the investigation to the potential value of that customer. There is little point in spending all of your potential profit on finding out whether the customer is likely to pay, for these customers you should consider a policy of rejecting or accepting such risks as a matter of course.

To conduct a credit check you can use an agency or, if you have the time and manpower, you can do them yourself. To conduct a check yourself, you should consider the following steps:

  • Ask the customer for a bank reference, but be aware that you will have to pay for this and it can only be supplied with the customer’s permission
  • Ask for a couple of trading references, including a specific question such as ’up to what level of trade credit is the customer considered a good risk?’
  • Ask the customer for their latest report and accounts, or a balance sheet and profit and loss account
  • Visit the business in person in order to meet the principals or directors and verify its authenticity

Categories of risk

You can then use this information to assess how risky you think a customer is and establish a credit limit. A common system is to have five categories of risk, ranging from the top category, which would be considered good for anything, to the bottom category, which you will only sell to on cash terms. You can then draw up credit limits and the number of days credit to apply to each category. These should relate to the size of the debts relative to your sales and what is considered standard practice in your industry.

Action Checklist

  • Check out the standard credit terms within your industry
  • Decide whether you have the resources to credit check in-house
  • Create a category system for rating potential customers according to the value of their business and their creditworthiness
  • Check out the D&B information in the Small Business Clinic