HomeBusiness Advice Guide Finance and Accounting Performing a Credit Check

Performing a Credit Check

Extending credit is a standard business practice, but one that can become problematic for any small business. For some of your customers this will be the only way that you can conduct proper business. So how do you protect yourself?

There are many ways to improve your success when dealing with this issue. Checking a customers credit history can be as simple as knowing who to call, or it can be much more complex. It can be very scary for a small business to loan resources or product without immediately seeing something back. Caution is always recommended when dealing with a new customer. Building any relationship takes time, and each case is different. There are important factors to consider when giving another company credit. Some things however are common sense issues - how long a company has been in business, etc. If a company has been in business for an extended period of time then your chance of getting reimbursed in a timely manner is more likely. Some standard methods to check credit history, and credit score include Credit References, Credit Reports (business and Personal), Letter of credit, and Financial Statements.

Credit References

References are a great baseline, and it's very important to follow them up. Typically a customer will chose there own credit references so it's acceptable to be a little skeptical here. A good method of performing a credit reference check is to ask the customer for a list of there suppliers so you can fill out the appropriate credit reference forms. Again, by following on your own leads you will have a better idea of what terms or conditions to ask of your potential customer. If at all possible you might be able to contact the customers financial lending institution and gather some relevant information.

Business Credit Report

To get a good idea on your potential customer's credit history it's important to access there business Credit History Report. While pricing ranges from $15 (standard one page outline) to $1000, the credit report will give you background into there financial history. Starting with a risk rating, you can start to predict how likely you are to get paid in a timely manner. From this credit report you will also see any legal information such as ongoing lawsuits, previous court judgments against them, liens, bankruptcy filings, etc. If you suspect that the company that you are going to deal with has little or no credit history, it is still a worthwhile endeavor. These credit reports can be received through fax, mail, and even online. If you chose to deal a lot with Credit Reporting Agencies (such as Transunion, Equifax, or myaaacredit.com) it would be wise to establish a relationship with one so that you can eventually reduce your cost based upon the number of requests that you submit. It may be possible to get a free credit report. If you are dealing with a Canadian company you can also access Canadian credit reports.

Personal Credit Report

For new companies or companies that are held privately, you may not be able to access there credit references, financial statements, or business credit report. The only option here is to do a personal credit report on the owner or CEO of the company. You can base the actions of the company on how that person has handled his or her own financial affairs. Going a little deeper into these types of companies by talking with there staff, managers, or investors, could also give you a good perspective on there credit history and habits.

Letter of Credit

Getting a letter of credit from a financial institution that deals with your potential customer can also help to reduce some of your concerns. For example, this is a good idea when you are dealing with a new company that requires a large order from you to start manufacturing so that they can produce future product for resale.

Understanding Financial statements

When interpreting financial statements for public companies (such as Oil and Gas, Nike, Reebok, Walmart, Meade Instruments) you need to start with the "Current Ratio" (the ratio of the company's current assets to its current liabilities) in conjunction with a credit report. This is a good indicator of the risk that you can take. If the ratio is below 1:1 then you should be very cautious in how far you extend the credit. The higher the ratio, 2:1 for example, the better your chances are.

Other Indicators for Consideration

Vigilance is always a good idea when giving credit. Make sure that you uphold a good record keeping strategy when dealing with company's that you are extending credit too. Here are some more things to watch for.

1. General economic conditions - Extending credit can also solely be based on your own company, and its current economic health. What risks are you willing to assume for potential growth? What losses can you potentially absorb?
2. Current business relationships - It is important to know what current relationships the company has with other suppliers. Have they overextended credit elsewhere? Are they willing to use collateral?
3. Nature of the business & its practices - Does the nature of the business encourage price reducing or discounting? If so, it could severely devalue the product you have with them and make repayment much harder.
4. Is the business cyclical or seasonal? - If you chose to do business with a company that has cyclical or seasonal turns, then be aware that there are more determining factors and risks involved.

When making your decisions about extending credit - always go with what your background research has found. Don't second guess what the numbers and history is showing, and make sure that you monitor your customers credit with you very closely. If you chose to extend credit to a company it's a prudent idea to keep track of your financial relationship with them so that problems don't arise, and you are always on top the credit that you have extended. For the small business manager there are many software related packages designed to help with customer relationship management. It's important to pick one that is adaptable for your current and ongoing needs. The Pro and Enterprise editions of Salesboom.com's hosted online CRM, for example, let's you customize and create your own tabs so that you can create your own red flags based upon what you expect from all your customers. Even though you may want to do business with potential customers for your own growth, remember that "no" is also an acceptable answer when asked to extend a line of credit. business lines of credit always come with some financial risk.

Try our free CRM software 30 day trial