"Let's face it-North America runs on credit, so it's a disadvantage if a business doesn't offer some form of it," says Frances McGuckin, CEO of SmallBizPro.com in Langley, British Columbia, and author of Big Ideas for Growing Your Small Business: How to Build Profits and Manage Growth (McGraw-Hill Ryerson). And yet, in tough times-which is precisely when business owners begin extending credit to lure those customers reluctant to part with cash-bankruptcies abound, and it can be riskier than ever to accept incremental payments. Just one or two deadbeat customers can push some businesses dangerously close to the dark side, and other business owners can find themselves so consumed with collections, they're left with little time to run their businesses.
"Extending credit is a [double]-edged sword," admits Robert Smith, 30, president of Robert Smith & Associates, a 5-year-old PR firm in Rockford, Illinois. "I give credit terms so more people can afford my publicity services. I also have people who still owe me money-and who will probably never pay."
To cut down on the latter, Smith implemented a reference-checking policy for his clients, 90 percent of which are small businesses and include celebrities and music production companies. If a customer wants to make payments, that customer has to supply three past business creditors as references. "I call them and find out, Did they pay on time? Did they pay the amount they were supposed to? If they were late, did they inform in advance?" says Smith. "The best predictor of the future is past performance. If they stiff everybody else, I don't see them treating me any differently."
The biggest mistake businesses make in extending credit, say experts, is failing to create-and follow-strict credit policies. That means first figuring out how much you can afford to have tied up in accounts receivable without losing sleep. Teresa Prim, a finance specialist with the Women's Business Development Center in Chicago, strongly advises doing regular cash-flow analyses to evaluate whether the businesses have sufficient working capital to handle various amounts of credit, as well as to determine what the payment terms will be.
Next you need a policy for evaluating credit risk. Not every purchase will require a credit application. "But for something involving a lot of money, you want to have an application, and you want to do a credit check," says Fred Steingold, an attorney in Ann Arbor, Michigan, and author of Legal Guide for Starting & Running a Small Business (Nolo). "And if you're dealing with an entity rather than an individual, you want to try to get someone to accept personal liability for the debt." Don't forget to get everything in writing, particularly in regard to delinquencies. "The biggest legal pitfall is probably not having the right documentation to make your case if you ultimately have to go to court," says Steingold.
When you do have a late-paying client, be diligent-and creative-about collections. Offering a discount for prompt payment in full can often inspire a delinquent customer to pay up. Don't be afraid to be the squeaky wheel, says McGuckin, who adds that businesses tend to give clients a little too much slack to keep them.
Smith changed his ways quickly, though, after just a few bad episodes. He readily admits he has lost business from customers who find his terms too tough. "But I get a better-quality prospect, a better lead and a better client," he says.
If, after all is said and done, extending credit sounds like an iffy business proposition, consider offering credit by way of plastic. True, you'll lose 2 to 6 percent to credit card issuers. "But the onus for collecting is off [of] you," says McGuckin. "It's a lot [fewer] headaches and a lot less paperwork."
C.J. Prince is executive editor of CEO Magazine. She can be reached at firstname.lastname@example.org.