With economy being highly competitive today, many small business owners want to explore every possible option to expand their customer base, increase sales and generate additional cash flow. One of the competitive advantages your business may gain is to offer goods shipped or services provided on account to your clients. In some cases, offering deferred payment is a must-have to gain new clients – this is especially true with government contracts and large corporate accounts. In other cases, offering post-payment options is a useful tool to gain additional sales revenue with new or existing clients. For some businesses, however, offering credit accounts to clients would not provide any additional benefits at all.

When making a decision on whether extend or not credit to your customers, you should consider additional hassle your business would have to deal with, with one of the major ones being the need to deal with late payments. Your business would inevitably have to face defaults on accounts sooner or later - according to United States Courts statistics, nearly 845,000 bankruptcy filings took place in 2015 alone (http://www.uscourts.gov/statistics/table/f-2/bankruptcy-filings/2015/12/31). Nevertheless, there are certain procedures you may implement aimed to avoid or minimize late payments from your customers.

Establish A Capital Base and Project Cash Flow

Small business often does not have benefits large corporations possess: access to quick and cheap financing, sufficient shareholder capital and diversified sales channels. Most small business owners have to rely on personal savings and personal credit. Therefore, it is vital to have a clear and honest understanding of where your business stands in terms of financial solvency: what are your cash reserves compared to monthly running costs, what kind of financing you may obtain quickly in case of negative cash flow, how your inventory looks like, and what are your monthly receipts and payouts. You need to gather and analyze your financials to get a clear picture of what percentage of sales you may perform on account without running into negative cash flow, and what resources you have handy in case you experience cash shortages. Once you come up with a number, you should stick to it; otherwise you run a risk of default on your obligations should your clients fail to pay on time. As your sales improve and business strengthens, you may reevaluate your sales structure.

Developing a Credit Policy

One of the best ways to minimize the impact of late payments from your customers is to avoid or minimize extending credit to potentially troublesome clients right from the start. This is exactly why you need to have a credit policy in place.

First, you should lay some ground rules, such as:
• The total amount of credit to be extended to all customers, based on your capital base and cash flows; • Credit terms you feel comfortable and safe to offer to your clients; • Minimal and maximal credit limits on accounts; • Incentives for early repayments and penalties for late payments. Second, you should develop a set of requirements for your customers to qualify for an account. These may vary, depending on your business specifics, amount of credit you are extending, your personal relations with key clients, and some other aspects. Typically, such requirements should be based on several factors to include: type and legal structure of business, age of business, sales volume, credit score, and ability to provide collateral or a personal guarantee.
Third, you should have all credit terms and conditions drafted into a contract agreement. Best way to do it is have a lawyer prepare it. However, if you are not financially comfortable having an attorney step in, you may consider other options, such as contacting your local Chamber of Commerce or Small Business Administration for help, buying a “Do-It-Yourself” legal kit, or looking for free templates online.

Perform Due Diligence

Banks do it, mortgage lenders do it, and you should do it. Many small businesses rely on personal relations with their clients and often make a mistake of granting or overextending credit when they should not have. Once you have your credit policy in place you should strictly stick to it, making exceptions in very rare cases, if any. When making financing decisions, sober look at things combined with mindset of a banker should prevail.

Main factors to take into consideration, when evaluating a potential borrower, are the following:

  • Length of doing business. Ideally, you should grant credit to well-established businesses. According to SBA statistics (https://www.sba.gov/sites/default/files/Business-Survival.pdf), about 35% of small businesses dissolve after 2 years of operation, and little under half pass a 5-year survival mark. Businesses that survive those 2 critical periods tend to stay afloat, no matter how good or bad economic conditions are.

  • Financial results. When accessing a repayment risk it is important to consider numbers, such as sales volume, cash reserves, short- and long-term liabilities, and overall financial results. Granting credit to clients that constantly report losses and have poor debt-to-asset ratios should be avoided.

  • Credit scores. Similarly to personal credit scores, business credit scores indicate probability of defaults on payments and bankruptcies. Obtaining a credit report on a business comes at a fee and requires your client’s consent. It is also a good idea to periodically review your clients’ credit history and scores.

  • Presence of co-signer or collateral. Many newly-formed businesses have the need for credit; however they may not possess the characteristics of a perfect borrower yet. That is why some business owners are willing and able to provide personal guarantees until their business gains solid financial reputation. In such cases, both, a business and a business owner, should be evaluated before making an underwriting decision.

Establish Clear Communication

Clear communication is vital in developing relations with your customers. Billing is no exclusion to this general rule.

First, you should invoice promptly. If you sell goods on account, an invoice should be presented at the time of shipment or delivery. If you provide services, it is not always possible to invoice right away, so you should send out a bill as early as possible. Should your business have chosen billing on a monthly basis, invoices should be sent out the following day billing cycle ends.

Second, you should make sure your customers have received all paperwork to issue payment. Surprisingly, many businesses still rely on regular post to send out invoices. It could be a good idea to switch to electronic billing, or duplicate paperwork by e-mail directly to person responsible for payables. This way you have a solid guarantee all your invoices are received on time and are not lost in mail or misplaced.

Third, your invoices should be easy to read and understand. Payment terms should be stated clearly with the amount due. Some businesses put vague terms, such as “Payable upon Receipt” or refer to contract agreement for due dates. Such an approach may cause confusion and delay payment receipt.

Endorsing Incentives and Penalties

A great way to minimize late payments and improve your cash flow is to offer discounts for early payments. Smarter customers always roam opportunities to save money, and this could be one of them. Most commonly used discount terms are “2/10 net 30”, meaning that the total amount due is payable within 30 days and a discount of 2% is applied if invoice is paid within 10 days. You may use your own terms, as long as they are acceptable to you and look appealing to your clients. You definitely should not expect that all your direct billed customers would exercise this option, but some certainly would.

Another good way to reward your customers for timely payments is throwing in bonuses or incentives at the end of a quarter or a year. This could be anything, ranging from small freebies to quite expensive items.

Likewise, you should strictly enforce your payment policy and have late fees stated in all contracts and invoices. Obligation to pay additional fees, interest and charges in case of a late payment is a great stimulus to stay current. You should remember that in periods of cash shortages most businesses tend to pay on contracts that have more stringent terms and leave less restrictive ones for later.