Nearly 60% of all B2B sales involve credit. Extending payment terms to your business customers can strengthen client relationships, increase sales, and provide flexibility that encourages repeat business. However, there are also risks. According to a review by the Federal Reserve, both delinquencies and charge-offs are at their highest point in about a decade.
Validating customer credit is a crucial step in safeguarding your business. It helps you make better decisions based on a client’s financial stability, payment history, and creditworthiness. By implementing thorough credit validation, you can better protect your business.
The Risks of Extending Payment Terms Without Credit Validation
Failing to do a business credit check before extending payment terms can leave your business vulnerable.
Increased Exposure to Late or Missed Payments
Without verifying a customer’s financial health, you risk doing business with a client who may have a history of late payments or defaults. This can disrupt your cash flow and force you to spend time chasing overdue invoices.
Strained Cash Flow and Operational Challenges
Cash flow is the lifeblood of any business. When payments are delayed, your ability to pay your suppliers, meet payroll, or invest in growth is compromised. Extending payment terms to unreliable clients can create liquidity issues and force you to rely on credit lines or loans, adding to your financial burden.
Potential Legal Disputes or Costly Collection Efforts
When clients fail to meet their financial obligations, you may need to engage in lengthy collection efforts or take legal action, which is costly, time-consuming, and can damage business relationships.
Key Factors to Assess When Running a Business Credit Check
A business credit check provides an independent view of a company’s financial reliability. It includes details on payment history, outstanding debts, and credit scores. Reviewing reports from the major credit bureaus gives you insight into whether a client has a track record of timely payments or a history of delinquencies. For example, an Experian business credit report provides you with an overall score, historical credit data, and predictions about future trends.
Credit reports from Experian, Equifax, or Dun & Bradstreet can also help you evaluate trade credit and payment history on other accounts, suggest credit limits, and check for bankruptcies, liens, or judgments that could indicate financial instability and make the client a higher credit risk.
Look for These Warning Signs
When assessing customer credit, watch for warning signs that indicate potential financial instability in a business credit check:
- Sudden changes in payment patterns or delays: Clients who were once prompt but start making late payments may be experiencing financial trouble. A pattern of delayed payments could signal liquidity problems.
- High debt-to-income ratio or declining financial performance: A company with a high debt level relative to its income may struggle to meet its obligations. Declining revenues or shrinking profit margins could also indicate financial instability.
- Frequent credit inquiries: Multiple recent credit inquiries can be a red flag. It may suggest that the business is seeking credit from various sources, potentially due to cash flow issues or financial distress.
- Negative reviews from trade references or suppliers: When trade references report inconsistent payments or mention strained relationships, it’s a sign of potential risk. Consistently negative feedback warrants further scrutiny.
Responding to Credit Concerns
When you run an Experian Business Credit Report or a report from Equifax or D&B and see concerns about a customer’s creditworthiness, take proactive steps to protect your business.
Review Payment Terms
If a customer’s credit profile raises concerns, consider modifying your payment terms. This could include reducing the payment cycle, raising interest rates on outstanding balances, requiring partial prepayment, or switching to cash-on-delivery for future transactions.
Request Personal Guarantees
For small or newly established businesses, ask for a personal guarantee from the owner. This provides added assurance, as the owner becomes personally liable for any unpaid balances. You can also do a personal credit check on the owner with permission.
Leverage Escrow Services
For large or high-risk deals, use escrow services to hold payments until all conditions are met. This reduces the risk of non-payment and ensures fair transactions for both parties.
Stay on Top of Collections
When customers miss payments, act swiftly. Send payment reminders, apply late fees (per your terms), and escalate to collections when necessary. Clear and consistent collection practices help enforce accountability.
Protect Your Business with Command Credit
Validating customer credit before extending payment terms is a fundamental practice for protecting your business. By consistently monitoring customer credit through business credit reports and automated alerts, you can detect financial changes early and adjust your terms accordingly.
With Command Credit, you can pull on-demand business credit reports from the major credit reporting bureaus and get account monitoring to warn you when there may be credit concerns. Get started today.