In a service business, anytime you deliver services without prior payment, you’re extending the customer credit. You are spending your time and money for the customer with the promise that they’ll reimburse you when the job is done. Even if you collect a deposit, you are financing the remaining portion of the outstanding balance.
Credit terms can be useful as a marketing tool. Offering credit can have a positive effect on your sales and make you more competitive. But you have to be careful because it also places your business at risk and has a draining effect on your cash flow.
The risk you take is that the customer won’t pay you at the agreed time—or at all. This is not a consideration to take lightly, especially if you offer credit terms to every customer. Over time, an aging recievables report can wreak havoc on your profitability and your sanity.
So while offering credit is something you can use to boost sales, you should grant this privilege carefully.
Creating a Credit Policy
The best way to protect your business is to establish a clear-cut credit policy. The policy should cover, in no uncertain terms, the following things:
1. Whether you offer credit terms at all
You have every right to withhold credit if you feel this is the best decision for your business.
2. What your available credit terms are
This may be as simple as ‘pay upon completion’ or a deposit/milestone arrangement like ‘50% before start, remainder on completion.’ It can also be a more structured long-term arrangement, such as 3, 6 or 12 month financing with compound interest.
3. Which products, services, and situations qualify for credit terms
You may decide to offer credit terms for everything you sell. You can also offer credit only on projects of a minimum size, or on certain products or services. Some businesses may offer special credit terms for a limited time to boost sales on a particular product (the car industry is famous for this.)
4. Financing charges
It is in your rights to apply a financing charge for extending credit, especially on long term arrangements. The money the customer borrows could be earning you interest from investments, and your financing charge compensates for this loss. This section of your policy should detail what the charges are and how they are calculated (eg compounded monthly, flat fee, etc.)
5. What the process for applying for credit is
This section details the process and paperwork the customer must complete in order to apply for credit. Accompanying forms such as a credit application and contract should also be created.
6. How credit applications are evaluated.
This dictates what criteria is used to determine whether you will extend credit, and on what terms. You may decide to vet every application with the credit bureau and/or require references. Some companies may establish a rating system based on a number of factors such as company age, size, payment history, etc. Or, it may be as simple as a manager making the final call.
7. How payments are billed and the payment terms.
Your policy should clearly state how and when a customer will repay the money you borrowed them. It should spell out when and how you bill, how long a customer has to pay the invoice, and what payment methods are accepted. If you offer repayment over a certain time period, this should state what interval you will collect payments (eg the first or fifteenth day of the month.) If you offer incremental payments as the project progresses, make sure to clealry define what triggers each payment (eg completion of certain milestones, signoffs on plans or designs, etc.) This is something that should also be in your proposal and/or contract.
8. Financial rewards/penalties for good/poor payment performance.
It is common to apply a penalty charge for overdue invoices. Some businesses choose reverse this and reward customers for early payments . For example, you could offer a 5% discount to customers who pay early. If any such penalties or rewards apply, be sure to include them in your contract.
9. Your collection process.
This should clearly outline the steps taken in order to collect the money owed to you by a customer. It should outline exactly what you will do, when, and what triggers the action. This may involve reminder letters or emails with varying degrees of firmness as invoices age.
10. Late / non-payment policy.
This is another important part of your collection process. This declares what happens if the customer is late or doesn’t pay their bill. It should outline what steps and taken and when. For example, you may decide to cut off services to a customer after a payment is 60 days overdue. You may decide to revoke or reclaim the products and services provided after a certain period of time. The policy should also outline if, and when, you take formal action such as hiring a collection agency or employing legal services to collect the amounts owing, and who will pay for these expenses. Anything you put here should also be part of your contract so the customer is aware of your policies and rights up front.
11. Changes to credit status.
The policy should also outline if, how and when the customer’s credit rating and/or status can be changed. For example, some companies may adjust a customers credit rating over time based on good or poor payment performance. Others may decide to revoke credit altogether after a certain amount of late or missed payments.
Train your staff on the new credit policy
If you have employees, particularly sales and administrative staff, make sure to clearly communicate and train them on your credit policy. This can’t be stressed enough. It’s not unheard of that a customer may agree with you on one set of terms, and then tell your employees something else later. Sometimes it’s a simple misunderstanding, and sometimes it can be outright manipulation. By training your staff, you can protect yourself from situations like this.
You’re not obliged to extend credit
Some customers will assume or expect that you’ll give them credit automatically. A few may even try to bully you or your staff into it. When this happens, remember that you are not obligated to extend anybody credit under any circumstances. It’s your business, and you have the right to decide how it should be run.
Of course, denying credit may mean you won’t get that customer’s business, and that’s a decision you’ll have to weigh carefully. But if a customer is trying to bully you into something, you might be better off without them anyway. Who needs that kind of stress?
Deposits strike a balance
One of the best practices to strike a balance between the customer’s desire to have the work done, and your ability to get paid for the work, is to charge a deposit. It’s a great practice because it distributes the risk between both parties. If a vendor is expected to deliver all of the work before getting paid, they are taking on 100% of the risk. The same goes for the customer if they pay in full up front. But a deposit splits this down the middle (or somewhere close to it) that ensures the work gets done and the vendor gets paid. Consider using a deposit as an alternative to financing projects in full or expecting the customer to pay up front.
And remember: It’s not personal
Money is a sticky topic for many people. It really helps to remember that this is business and not personal. The best approach is to separate your emotions and feelings from it completely. This will make you better at dealing with money and business in general.
If you want some inspiration on how to deal emotionally with money, I highly recommend reading Cold Hard Truth by Kevin O’Leary. He’s probably the best example of the ‘all business in the boardroom‘ mentality you need to deal with money effectively.