If banks won’t lend to small businesses, why should you?
That might seem like an odd question. But lately, I’ve heard from a number of Axxess clients who’ve been burned by clients or customers who spend big but don’t pay their bills. While collections can be a challenge in any economic environment, it’s especially difficult now.
I’m talking about extending trade credit, the practice of delivering a product or service to your customers and giving them 30, 60 or 90 days to pay. Bigger than bank loans, credit lines, equipment leases or any other form of commercial credit, trade credit is the grease that makes the wheels of our economy go ’round.
Back when I was starting NetCreations in the mid-1990s, I remember filling out an application for trade credit from DM News, the bible of the direct-marketing industry, where we had recently started to advertise. Since we were still a home- based business, it wasn’t easy coming up with the names of three vendors who’d extended us credit in the past. In fact, I think I put down our accountant as one of them. But somehow we managed to squeak through.
As our company grew, we began to extend trade credit to our customers as well. Even though we required the customer’s first order to be prepaid (a standard practice in the list-rental business), we typically gave established customers 30 days to pay, even though some of our corporate customers took 60 days or longer. Everything went fine until the dotcom bubble burst, and we were left holding the bag for roughly half a million dollars in bad debt.
How could I have let that happen? Well, even though I’m a financially responsible businessperson who watches my accounts receivable like a hawk, there was no way that we could demand upfront payment from companies that were spending hundreds of thousands of dollars with us–not unless we wanted them defect to our competitors. So even though we reduced the credit limit of some customers whose financial health we thought was questionable, we still ended up getting burned.
What’s the solution? For starters, it’s important to know your customer. It’s one thing to extend trade credit to a Fortune 1000 company (unless its name is General Motors or AIG); it’s another to give credit to a pre-revenue startup or faltering condo developer.
It’s also important to set limits. No matter how big the customer is, it’s always a good idea to require the first order to be prepaid (or, if you’re a professional services provider, to require a retainer). After that, depending on the customer’s size, industry, credit-worthiness and the amount of money the customer plans to spend with you, you’ll want to establish a credit limit–that is, the size of the bill the customer can have outstanding at any given time before he’s got to send you a check.
While I realize it’s not easy to exercise financial discipline at a time like this, you’ve got to bite the bullet and do it. Otherwise, you may find yourself standing at the back of the line along with other unsecured creditors when your customer goes Chapter 7.
There’s also another reason it’s important to draw the line on trade credit. Since commercial banks are hoarding the government’s bailout money for fear of incurring losses on consumer mortgages and small-business loans, many small-business owners are turning to factors and other asset-based lenders for financing. Without receivables that can readily be turned into cash, if your customer has credit problems, they may soon become your own.
So the next time an over-extended customer or client asks for more credit before he’ll buy, ask yourself how you’ll feel 90 days from now when you’re chasing him around town for a check.
This entry was posted on Tuesday, March 24th, 2009 at 6:33 am and is filed under Business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.One Response to “Trade Credit Can Come Back to Bite”
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April 6th, 2009 at 9:11 pm
Another word on Trade Credit… Finally the day comes when that long sought after prospect hands you an order. In these cash tight times you need to understand if this is the result of your persistence or the prospect’s lack of cash. A company who is unable to pay their current vendors will often seek 2nd sources. Yes, they are fighting to survive, but is it wise for you to become their next unsecured lender?
It may be in your best interest to run a credit report. One credit reporting agency, D&B, provides a PAYDEX and Payment Summary report which is fairly easy to understand.