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Friday, August 27, 2010

Establish a credit-approval process to avoid bad debt

 

Before establishing a credit approval process, business owners must understand its importance.

Too many owners believe “sales” are the most important thing in business — everything starts with sales revenues and nothing else matters as much.
 
While there is some truth to this notion, a dollar that is not collected from a sale may be more injurious to the business than not making that sale in the first place.
 
For instance, a company that utilizes heavy equipment, fuel, labor and raw materials will spend money or incur trade debt providing products and services.  If the company isn’t paid by its customer, its loss will be worse than not making the sale. The company will be out the cost of using that piece of equipment, money spent on fuel, wages paid the driver and the associated payroll taxes and materials needed for the product.
 
While a sale is important — it is not truly a sale that benefits your business until cash is collected.
 
Obviously, cash up front is better, and that can be payment with a credit card, debit card or with a check.
 
However, if and when a business establishes a credit account with a customer, it should follow these steps before approving that line of credit.
 
• Have the customer complete a credit application listing the basics of the business such as the legal name, physical and mailing address, type of entity, how long in business, owner’s names, tax ID number, existing credit references and the amount of credit desired.
 
• Identify the person authorized to conduct business. Verify the information through Internet resources and with phone calls to credit references. Record the results of the research, including the date and to whom you spoke.
 
It goes without saying that the higher the credit limit, the more due diligence is required.  If the credit limit will be large in the business’s view, obtain a Dun & Bradstreet report through the Internet or a business credit report from a number of places, including Experian.
 
• Explain repayment terms, as any discounts for very prompt payment and late charges should be explained upfront. Significant discounts should be given for prompt payment, and late charges should be enforced for past-due payments. 
 
• Enter customer data into the business’s computer or accounting system, which should include the credit limit. Your system should have the ability to flag and not accept orders from customers who are past due, such as being over 60 days from invoice when normal terms are within 30 days.
 
A past-due customer should be contacted by a designated employee to set up a date for payment, which should be recorded on the computer or on an account card. If the payment is not received as promised, a follow-up should be made.
 
Unfortunately, some accounts will not pay until they are called by the creditor.
 
If no payment is received, it may be necessary to involve an attorney, especially if the amount owed is substantial. Collection attorneys might work for a percentage of the amount collected.
 
For lower dollar amounts, it may be more cost effective for a business to gather a number of smaller accounts and sell those accounts to a collection agency which will reimburse the business a small percentage of the outstanding balances.
 
It’s not an ideal solution; however, recouping some of the loss is better than nothing.
 
No business wants to go through a past-due or collection process, and businesses are wise to minimize the risks of non-payment through an established credit-approval process. 
 
 
Contact Fred Dawson Jr. is an executive vice president and the chief credit officer for Commerce Bank of Arizona, an Arizona based community bank specializing in serving small to mid-size businesses in Arizona. He may be reached at fdawson@commercebankaz.com or (520) 325-5200.
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