Published October 5, 2011

How You Can Create a Sound Small Business Credit Policy

Small business owners have many issues to focus on while operating a small business. One issue that causes headaches and creates high stress levels is when a customer or business partner doesn't come through financially.

Late or unpaid invoices result in cash flow problems that you should not have to face. Even a business relationship can go sour if your business partner does not live up to their financial agreement.

By setting up a small business credit policy and assessing credit properly, you can avoid or at least reduce the missing cash flow.

While it may seem easy to simply ask for cash up front on each order rather than bill your customers, sometimes the customer is insistent upon an invoicing system with payment terms, and in some cases, invoicing is the only answer to a complex order/assembly/delivery system with your customers.

However, in order to assure you have fewer worries over cash flow, use the following as your guideline in setting up your small business credit policy.

Be Up Front About Your Credit Terms

Before you ever consider granting credit terms to a customer or business partner, be sure you disclose your small business credit policy with clear terms. If your customers know up front what you expect of them financially, they are more likely to abide by the rules you set. Be sure you disclose full details such as:

  • Full payment due (10 days, 30 days, etc)
  • Net terms, if any (for instance, a 1% discount if paid within 10 days)
  • When payment is delinquent (day 31, 5 days after due date, etc.)
  • Interest rate on delinquent amounts (be reasonable - 8-10% is standard)
  • How interest is calculated (for instance, calculated annually but compounded weekly)
  • Steps you take on serious delinquent accounts (letter at 60 days, to collection agency at 90 days, etc.)
  • Whether you report payment behaviors to credit reporting agencies

Run a Credit Report

Assessing credit accurately can be facilitated if you have a credit report in hand from your applicant. Whether it is a customer or a potential business partner, if they expect you to wait for payment on an order or business deal, you should require them to complete a credit application which grants you the right to pull their credit score.

Creating a credit application is easy. A simple Google search can deliver plenty of suitable models. Be sure to ask for a Social Security number or a Federal Employer Tax ID Number (FEIN) to give to the credit agencies.

The report will disclose how long the applicant has maintained a credit history, how well they make current payment obligations, whether they have current late payments reported (and how many), and if they have any prior accounts in collections. Assessing credit worthiness with this report is much easier when you can see an actual record of previous history.

Ask for a Balance Sheet and Income Statement

It is common business practice to request a current balance sheet and recent income statements. These financial documents can be essential to assessing credit worthiness. Check whether the applicant has sufficient assets. On the income statement, assure that they have a good history of profitability.

Check References

You can also ask for references to help with assessing credit. Contact previous account holders and ask their opinion and advice on the applicant's ability to pay on time.

Consider Requesting a Deposit

If a business partner or customer does not fully meet your standards after assessing credit, you can still grant invoicing or credit terms with a deposit paid. You might consider a deposit of $200, $500, or more depending on how much money you will be 'carrying' on average.

Be Diligent with Your Collections

As part of your small business credit policy, be sure you carry through on collection processes. It might mean a phone call a day after payment was due or sending letters when promised in your policy. When your customers and business partners know you mean to carry through, they are more likely to live up to their end of the agreement.