Credit Evaluation and Approval

When developing credit policies, small businesses must consider the cost involved in granting credit and the impact allowing credit purchases will have on cash flow. Before beginning to grant credit to customers, companies need to be sure that they can maintain enough working capital to pay operating expenses while carrying accounts receivable. If a small business does decide to grant credit, it should not merely adopt the policies that are typical of its industry. Blindly using the same credit policies as competitors does not offer a small business any advantage, and can even prove harmful if the company's situation is atypical. Instead, small businesses should develop a detailed credit policy that is compatible with their long-term goals.

The decision about whether to grant credit to a certain customer must be evaluated on a case-by-case basis. Each small business that grapples with this issue needs to gather and evaluate financial information, decide whether to grant credit and if so how much, and communicate the decision to the customer in a timely manner. At a minimum, the information gathered about a credit applicant should include its name and address, Social Security number (for individuals), bank and/or trade references, employment and income information (for individuals), and financial statements (for companies). The goal is to form an assessment of the character, reputation, financial situation, and collateral circumstances of the applicant.

Credit Programs for Business Customers

There are many avenues available to small businesses for gathering information about credit applicants. In the case of business customers, a small business's sales force can often collect trade references and financial statements from potential customers. The small business can also contact local attorneys to find out about liens, claims, or actions pending against the applicant, and can hire independent accountants to verify financial information. An analysis of a company's debts, assets, and investments can provide a solid picture of its credit worthiness, particularly when the data are compared to a composite of companies of similar size in similar industries. It is important to note that all information gathered in the credit approval process should be held strictly confidential.

Credit Programs for Individual Consumers

Consumer credit bureaus are a useful resource for small businesses in evaluating the credit worthiness of individual customers. These bureaus maintain records of consumers' experiences with banks, retailers, doctors, hospitals, finance companies, automobile dealers, etc. They are able to provide this information in the form of a computerized credit report, often with a weighted score. Still, credit bureau reports do have some potential for error, so small businesses should not necessarily use them as the only source of consumer credit information. It is also important to note that credit granted to consumers is subject to the federal Truth in Lending Law, as well as a number of other federal statutes.

Many small businesses, particularly in the retail trade, choose to participate in major credit card plans. Allowing customers to pay with credit cards offers businesses a number of advantages. Since most large retailers provide this service to customers, accepting credit cards helps small businesses compete for new customers and retain old ones. In addition, customers are often tempted to spend more when they do not have to pay cash. The convenience of credit card purchases may also attract new business from travelers who do not wish to carry large sums of cash. Finally, credit card programs enable small businesses to receive payment more quickly than they could with an individual credit account system. The main disadvantage to participating in credit card plans is cost, which may include card reading and verification machinery, fees, and a percentage of sales. Credit cards also make it easier for customers to return merchandise or refuse to pay for items with which they are dissatisfied. Still, in this technological age, few small businesses (or large ones, for that matter) can afford to forsake membership in some sort of credit card plan.

Another common type of consumer credit is an installment plan, which is commonly offered by sellers of durable goods such as furniture or appliances. After credit approval, the customer makes a down payment and takes delivery of the merchandise, then makes monthly payments to pay off the balance. The down payment should always be large enough to make the purchaser feel like an owner rather than a renter, and the payments should be timed so that the item is paid off at a faster rate than it is likely to depreciate from use. The merchandise acts as collateral and can be repossessed in the case of nonpayment. Although installment plans can tie up a small business's capital for a relatively long period of time, it is possible to transfer such contracts to a sales finance company for cash.