For many small businesses, selling on credit is a major strategy for achieving increased sales and ensuring customer loyalty. This strategy if not properly managed can lead to huge losses and possible liquidation of the business.
There is therefore a need to set clear guidelines on credit sales that will help minimize the exposure of the business to bad debts whilst improving its cash flow. This is known as credit management. The following steps should be considered by a small business intent on offering credit directly to its customers.
Establish clear Terms of Sales
A small business should establish clear terms that guides when and how it intends to sell on credit. These terms should include:
- · Date when payment is due
- · Discount given or extra costs attached
- · How payment should be made (cash, post dated cheque, bank transfer etc)
- · Penalty for late payment
Decide a Form of Contract
A contract document that highlights the terms and conditions for every sale made on credit should be opened. The type of credit instrument should also be specified. A sales receipt (also known as sale on “open account”) or letter of credit should be provided to the debtor.
Access the Customer’s Credit Worthiness
The business should ascertain the credit worthiness of a customer before a credit sale is made. A careful credit analysis should be carried out by looking at the following parameters:
- Availability of assets as collateral
- Capacity to pay (does the customer have a clear source of income?)
- The character of customer guarantors
- Previous credit history
Set Credit Limits
A small business should place a limit on how much credit can be granted. This will help ensure that outstanding debts by customers do not erode the cash flow of the business and adversely affect its day to day operations and growth.
Establish a Credit Collection Policy
A credit management department with a designated staff in charge as well as an accounting system that includes debtors' records should be established. This will enable the business monitors and ensures that all outstanding payments by debtors are made as at when due.
Study and Understand the Laws Pertaining to Credit
It is important that to study and understand the necessary laws pertaining to credit. These laws including the Fair Credit Reporting Act (FCRA), Equal Credit Opportunity, Fair Credit and Charge Card Disclosure Act and Fair Debt Collections Practices Act should be carefully understood before offering credit directly to customers.
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