In business you will rarely come upon a more important task than
that of determining the creditworthiness of your patrons. Poor credit decisions inevitably
lead to the demise of your business. When you extend credit to customers, you are
providing them a "cash loan" equal to the amount of their purchase. So use the
same guidelines bankers use when determining loan creditworthiness. These guidelines can
be easily remembered as "The Seven C's of Credit."
Character. You must be comfortable with the
borrower's integrity and confidence in his willingness to repay you. Have you met the
customer? What is his reputation in the community? Is he an upstanding guy or is he a dead
beat? You may consider checking references with other business-owners with which the
customer does business.
Credit History. No financial institution would ever
loan money to an applicant without first checking his or her credit history. As a
potential creditor, you also have the legal right to obtain the borrower's credit report
and examine it in determining whether or not you can risk extending the credit. Always
tell the customer you will be checking his credit report and get written permission before
actually doing so.
Career History. Ask about the borrower's business.
Is it a successful business venture? Has he been in it for a while? Has he had failed
business ventures in the past? His past successes or failures may be determinative of his
future business success.
Capacity. In what capacity is your credit going to
be used in his business? Is it part of his inventory? Will the use of your goods enable
him to generate sufficient funds to repay you and any other creditors? You may consider
going over his inventory records with him. The faster he moves his inventory, the more
likely his business is a success. And the more likely he will be coming back to order from
you again soon.
Capital. What is the borrower's financial net
worth? A customer with a positive net worth can survive low cash flow times in his
business and still pay your invoices.
Collateral. You may consider extending only
"secured credit." This usually means having the customer pledge real estate or
his inventory on a UCC in exchange for your providing the credit. If he defaults on the
loan, you get the pledged property. Just make sure the property hasn't been pledged
before, or you'll have to get in line if the customer defaults.
Conditions. Always make sure the conditions of the
sale are clear and in writing, signed by the borrower. This includes payment dates and
amounts. If he defaults on any of the conditions, your collection efforts will go much
more smoothly if the conditions of the credit are clear.
Once you have "sailed through" The Seven C's to determine
the creditworthiness of your customer, be sure to consider this last bonus "C"
before making your final decision:
Collections. Bear in mind your own receivables. If
your cash flow isn't what it needs to be, you may not be able to afford extending more
credit at this time. Remember that your customers' overdue accounts with you significantly
impact your own company's creditworthiness.
Polk & Associates
April 1998