Trade credit: To sell or not to sell

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Bikky Khosla | 25 Sep, 2012
For small businesses, selling on credit has become a way of doing business. While some see opportunity in it, some others consider it a ball and chain, but whatever the reason it's a risk most small and medium enterprises are willing to take. Saying a 'no' means losing an opportunity of extending sales, or suffering a setback against competitors who are open to selling in return for a promise to pay.

But promises can easily be broken. Credit helps in selling but it also involves risks that may cost your small business an arm and a leg. So, before extending credit to a customer, you need to think twice. Selling on credit can benefit your business only when you manage the credit facility appropriately - you need to follow guidelines, lower risks of not being paid back, and get the basics right to play it safe.

First of all, I suggest every SME to formulate and follow a credit policy - a set of measures, standards and benchmarks that address basic issues like guidelines for granting credit, person authorized to grant credit, evaluation procedure of credit worthiness, credit limits, method to be followed to check customer accounts, penalties for late payment, delivery obligations or remedies if a customer fails to pay the debt, interest rate (and its calculation method) on delinquent amounts, collections procedure, standard terms, etc.

Secondly, never extend credit without putting your credit terms in writing. Craft out a credit application, and always ask a customer to complete and sign the application. Some points that must not be missed include customer information (company's legal name, entity type), contact information, bank account information, bank references, trade references, partners and guarantors, and terms of credit. The application doesn't need to be long, but should be carefully thought-out as this is after all a legal document.

Finally, always play the game safe. If a customers asks to wait for payment on an order, ask for a credit report on his business to determine his creditworthiness. Also, extend credit only when your business has necessary cash flow to support the move, the credit limit is not greater than the risk you can afford to take, and there is a collection policy in place to protect your accounts receivables.

There are risks as well as rewards, but for most of us offering trade credit hardly depends on our choice. It has become an industry practice, and there are many businesses where it is nearly unavoidable. So, the wisest thing to do is to grab the benefits and avoid the pitfalls. The measures set out above, while they may not entirely eliminate the risks involved, will help make sure you have the dos and don'ts in order.