All new applicants for credit accounts with your business should be properly screened, to ascertain their reliability. It is a good idea to create a form for your customers to fill out when they apply for a line of credit, setting standards that they must meet before you will approve their application. The form should address the following three Cs of determining suitability:
Character – This is a fairly subjective area of judgement, where you determine a customer’s reliability based on their acknowledgement of a moral obligation to pay their debt. It may be a good idea to attain some level of familiarity with your customers, especially if you are running a small business, before offering them a line of credit. This will make it easier for you to accurately judge their character, and also give you a chance to monitor their previous purchase and payment habits.
Capacity to repay – A customer’s ability to pay their accounts can be determined by an examination of their financial statements and business plan. References from the customer’s bank, previous suppliers or from credit reporting agencies can also help you to decide whether or not they have the capacity to pay their accounts. Reports from credit agencies will outline whether a business has ever taken too long to pay a debt, whether they have current overdue accounts or if they have ever defaulted on a loan.
Collateral – In case the situation does arise where the customer does not have the finances available to settle their account with you, it is important for the security of your business that they offer some form of collateral as surety on their debt. The value of the collateral should be roughly commensurate with the value of the product or service that you have provided for this customer.