Selling on Credit and its Risks

• As with many things in life, selling on credit has both good and bad points. Generally, the good points are obvious: the likelihood of increased business and convenience for customers. The bad points, of course, have to do with the time consuming, but absolutely necessary, set up procedures (if you're going to do it right) and the very real possibility of the customer not paying.

  The first issue you will need to deal with is whether or not selling on credit is even necessary for your particular business. Frankly, there are businesses where it is nearly unavoidable, like a health care service or even the government. Food services, like restaurants, might need a good check policy but not a credit (pay ya later) policy. "Buy now, pay later" is the key issue. Credit is a "promise to pay," and you'd better know the rules if you are going to play this game.

  So, you must decide: What is my product or service and who are my customers? Knowing the payment patterns of your customers and what is common for similar businesses is the first step. Check with your trade association, or financial information resources such as RMA Annual Statement Studies to find out what is common in your industry. This is also an area where your banker may be able to provide relevant information.

  For instance, it is common for the state or federal government to take 60-90 days to pay. In a medical/dental service that accepts insurance, you may be waiting weeks or months to get paid. Establishing your credit and payment policy is extremely important in this industry. Insurance is an agreement between the customer and her insurance company, NOT the service provider and the insurance company. If you accept insurance know that the check will likely go directly to the patient, not you. An everyday occurrence is the patient spending the insurance money on whatever and then sending you twenty bucks a month. Many insurance companies offer to send the payment directly to the doctor. The patient must give her permission (in writing) for this to happen. You will need to establish a policy, incorporate it into a document that the customer signs, and make sure it is clear and the customer understands what s/he is signing.

  It is important to determine if it is feasible for you to start offering credit at all. It requires discipline in the form of taking credit applications, setting policies for your credit standards, reviewing the applications, rechecking them periodically, etc. If your business is young, you may want to wait until you feel a bit more in control of things. It's just one more thing to worry about. Besides you could probably put together a credit card program with your bank and one of the major credit card companies like MasterCard or Visa in fairly rapid order. Remember, there will be fee assessed and you'll have to decide if you can afford it. But this fee may be well worth it if you don't have the resources to establish good credit policies and practice them!

  If you decide that you are ready to offer credit directly to your customers, then here are some of the steps you should consider:

  1. Get training.
     If you don't have previous experience with selling on credit (again, we don't mean accepting credit cards), it is a good idea to get some training on the credit process. Many credit bureaus offer such training at little or no cost. The bureau will expect that you will give them business down the road, but they offer a service that you will most likely need. You might also talk with your banker and get her suggestions for training programs. If she is a member of RMA, they are a great resource for credit training information.
  2. Establish credit policies
     You will need to determine a number of credit related policies. Will you sell on credit to all customers? What type of terms will you offer? What amount of credit will you allow? What type of credit and payment history will be acceptable? Will you assess late charges if the customer doesn't make payment on time?
     
     Many of these policies can involve legal issues, so it is a good idea to draft up your policies and have your attorney review them for you.
  3. Establish procedures for accepting applications.
     The credit bureau can offer assistance in this area as well. Every "type" of business has certain characteristics that need to be addressed. The agency can help you design an application so that you have the information you need to lower your risks.
     
     It is not recommended that you accept credit applications over the phone when you first get started. Face to face encounters can give you some indication of a persons ability to pay (although you should never use appearance to deny or grant credit). It is also a great time to explain your business. Mail-in applications are fine, too. There is a lot of credit application fraud out there, so discuss this with the credit agency and get them to give you prevention tips.
  4. Establish your "credit standards".
     The customer's credit applications should include their outstanding debt and current income (amount and source). No one should spend more than 20% of their gross pay on credit payments. Determining a client's debt ratio will make it clear whether you should give them more credit. If the debt ratio turns out to be 5% higher than the recommended amount, then the client may have difficulty paying back the debt. Income to pay for debt may not be adequate. Perhaps if the client gave a larger down payment (the larger the better), you may reassess. But its better to turn them down and lose the sale than to find yourself trying to collect a bad debt.
     
     This is an important step, so don't skip it. If you have trouble determining your credit standards, talk with your banker and accountant and get them to help or refer you to resources that can. Once again, offering credit is serious business. If mishandled, it can negatively impact your cash flow or even the viability of your business.
  5. Validate information on the application and check history.
     Joining a credit bureau is an enormous help. A credit bureau has the data system that logs the payment history of credit customers. Good and bad credit is reported. You can receive credit history reports for a fee from the credit bureau. The reports are easy to read once you "learn the code" - and again the credit bureau can help you with that.
     
     If you expect to be obtaining a large number of credit reports, you can get set-up to access the bureau's computer via your computer. Entering in a potential clients name, address and social security number will provide you with a report very quickly. So, while the customer is on the floor, you can allow for instant credit after reading the file. It may be a bit uncomfortable if the person's credit is not accepted (here's another policy and procedure that you will need). By law, you must give them written disclosure of why they were denied credit. Then the customer has a right to dispute the information -- typically it will be something on the credit report that the customer will have to take up with the reporting agency. Once again, the credit bureau is a good resource for training on what you should say to a customer in these circumstances.
  6. Establish a collection policy and stick to it.
     It is generally a bad idea to let accounts get over 120 days old. Age your accounts on a regular basis and get busy collecting those that exceed a preestablished limit. Make sure that you know both your rights and the consumer's with respect to debt collection practices.
  7. Know the laws pertaining to credit
     Now, if you're going to utilize the credit bureau, then you must follow the Fair Credit Reporting Act (FCRA). Get yourself thoroughly trained in this area. In October of 1997 the new FCRA regulations will take effect. You can be in a lot of trouble if you violate the law. You may also need to follow Equal Credit Opportunity, Fair Credit and Charge Card Disclosure Act and Fair Debt Collections Practices Act. Each state may have different requirements. If your state has no requirements or has weaker requirements then the federal law, follow the federal law. Please, take the time to learn these laws, and consult with your attorney as appropriate.

(Montana Women's Capital Fund, 4/97)