As many small businesses grow and expand their customer base, a big question business owners face is how to increase cash flow and maintain customer loyalty. One of the ways to do that is to offer credit to customers. By offering credit, you can increase your working capital, increase sales, and attract new customers.
If you’re wondering if your business should extend credit, here are the things to know:
Providing credit as an option can…
- increase sales by as much as 50 percent.
- and give your business a competitive edge and help increase customer loyalty.
- effect your cash flow due to late payments.
We’re going to go into more detail and discuss the implications of extending credit as well as the upsides and downsides. But if this is something that could work for your small business and help it grow, it is definitely something to talk to your bank or lending partner about.
What Does It Mean to Extend Credit?
Extending credit to customers allows them to purchase goods or services and pay for them later on. It’s like using a credit card where you (the business owner) are the lender. Here’s how it would work:
- The customer decides they want to buy something in your store on credit.
- If they have an existing credit plan with you, then you proceed to check out.
- If not, see below for how to start a credit application for them.
- The customer agrees to the payment terms for the extension of credit.
- The customer pays you at the agreed-upon date.
It’s as easy as that. Three steps and you add a new customer.
Extending credit is not an unusual thing in business. Credit cards are a form of credit, as are bank checks. In fact, the only non-form of credit is cash because it immediately provides you with the money due. Businesses offer payment options (like credit cards and checks) because it leads to increased sales and more potential customers.
How to Start a Credit Policy at Your Business
When you’ve decided that you want to start extending credit to your customers, there are some steps to follow to ensure you have everything you need to issue successful credit terms to customers.
- Vet your customers. Require customers to fill out an application to make sure that they are not a credit risk. You do not want to extend credit and payment terms to someone who has bad debt. Instead, ensure that you are only extending credit to creditworthy customers with great payment history.
- If you’re looking at extending credit to vendors, the same rules apply, and you can use the Business Credit Report guide to help.
- Have a clear policy. Have it in writing when you will be invoicing customers and outline your credit practices.
- You may need to be flexible for longer payment terms, but make sure the terms (Net-30, Net-60, et cetera) are clear for the customer.
- Keep organized. Ensure that you have a system for employees about keeping track of accounts receivable and outstanding debts.
- Collect payment. Offer a few different repayment options (e.g., check, cash, wire transfer). Don’t be afraid to implement interest rates for customers who are behind on payments and, in a worst-case scenario, use a collection agency to collect bad debts.
It is important to stick to your credit policy once you’ve made it, especially to ensure customer loyalty and help your employees. Starting the credit policy ensures your employees know how to offer credit to customers while the detailed bullet points below help set up potential customers.
Credit Policy for Customers
When specifically looking at customers, you want to make sure that you have specific information that you can use to get paid and ensure creditworthiness for customers. You should craft a credit policy that includes:
- Contact information for how you can be reached. You want to make sure that it has your hours, physical or mailing address, email address, telephone number, and website. This ensures you can be reached if the customer has any issues. It should also include where they can send payment.
- Although your policy will outline your credit practices, you want to make sure that your payment terms are clear. You may be instituting a Net 30 or deferred payment plan and your customers need to know when invoices are due.
- Are there penalties or interest for late payments? Customers need to know this – and you should make sure to have a plan so that you won’t be taken advantage of with bad debt. Institute late fees and interest rates to charge after a certain date has passed (e.g., one week after the due date).
- Also, be sure to note when payments will be considered delinquent. This information should be upfront and not hidden in the fine print.
- Just like any other business, say upfront what forms of payment you accept. If you’re extending credit, you might prefer cash, wire transfers, or ACH transactions, but maybe you also accept credit or debit cards and checks. Customers need to know upfront how to get payment to you and what method you prefer.
- Since you’re extending credit, you might want to ensure that you’re getting payment immediately via cash or bank transfer. This also could cut down on other fees for bounced checks or credit card transactions.
You can put disclaimers with your policy and set credit limits, but the bottom line is that you need to get paid for goods sold.
Some Pros and Cons of Extending Credit
We sifted through lists of pros and cons about extending credit to determine what most people are saying. We found five main pros and cons:
- Credit can lead to increased sales
- Offering credit gives you a competitive edge
- Building customer loyalty and trust
- Enhancing reputation as a reliable and stable business
- More customers and more sales
- Delayed payment with a risk of not getting paid that impacts your cash flow
- Extra investment of time and resources to track down unpaid credits
- Credit collection fees for late-paying customers may lose the business money
- Need to determine which customers are creditworthy, leading you to potentially turn down customers
- Late paying customers and customers denied credit may react badly, impacting your reputation
These pros and cons will hopefully help you decide whether the implications of your business extending credit are worthwhile. As with any business decision, it is important to exercise caution and due diligence in assessing your options.
Other Kinds of Credit for Your Business
When looking at extending credit for your business, there are two other forms we wanted to quickly discuss. Vendors and lenders both offer different kinds of credit for your business that is helpful to know about.
Lenders and banks already know whether your business has a good credit history. Your credit (which is very similar to a personal credit score) can determine whether you are eligible for loans or other funding. Banks can extend credit in this way to your business to help with funding and ensure that you can stay afloat.
As businesses are reopening and e-commerce is picking up, many small businesses are figuring out how to pay suppliers and sell to new vendors. This is where trade credit with vendors comes into play. Trade credit is a loan extended by one business to another (typically in a vendor relationship) where the goods are bought with credit with the cash coming at a later date. This is similar to how you, as a business owner, might extend credit to a customer.
Both of these credit options can be important to helping your business run and succeed. Although, with all credit, they can limit your cash flow. As a small business, it is important to weigh the pros and cons of extending or receiving credit.
Many businesses offer credit extensions already. In fact, we’ve talked about trade credit options for small businesses before. But extending credit to customers can help your own business while increasing your working capital and cash flow in the long run.
As businesses are opening back up, and customers are buying more, it may help your brand and business to extend credit to customers. That goodwill could translate to new customers, although it will reduce your immediate cashflow.
At the end of the day, every business is different. Before making any decisions, it’s important to look at how the pros and cons will affect your working capital and ability to stay open. Create a credit policy and determine if it is something that works for your bottom line.