Credit & Finance: The risks and rewards of extending credit

New customer prospects are exciting. They represent company growth opportunities and greater commissions for a sales representative. But they aren’t without risk. 

Evaluating a potential new customer for trade credit is a crucial process for a business to ensure it extends credit to reliable and financially stable clients. A thorough evaluation helps mitigate risk and maintain healthy cash flow.  

As credit extenders, two key questions must be answered: first, is the potential new customer legitimate? In today’s produce business environment, impersonation fraud is rampant.

Second, if they place orders, will they be able to pay for product and/or services?

A critical error when engaging in new business is not doing the necessary research to protect against risk. Painful lessons are learned when new business opportunities are not properly vetted.

Here are eight key steps and considerations for evaluating a potential or new customer for trade credit.

1) Credit Application

It all starts with a credit application—ask every new or prospective customer to complete a credit application.

This form should gather essential information such as business details (name, address, contact information, and type of business); financial information (annual revenue, number of employees, and bank references); and trade references (names and contact details of other suppliers who have worked with the customer).

This critical and necessary document source should paint a clear picture of the company and management team you’re looking to do business with. If you don’t know who you’re dealing with, you shouldn’t be selling them produce or extending services.

If you don’t have a credit application process, Blue Book Services can help. Blue Book now offers a “Credit Application Request” feature to help businesses gather customer insights for more informed business decisions. 

Contact a Blue Book customer success representative for more information.

2) Credit History, Rating, and Score

Assessing a prospective customer’s credit history and Blue Book rating and score information is vital to evaluating creditworthiness.

Key information sources and data points are found in credit reports, including an industry-specific Blue Book business report to check for any negative indicators and payment trends.

Negative marks might include slow pay, lawsuits, or other claims activity.

Did you know Blue Book also offers Experian-supplemented business reports as well as a deep dive into public records? Be sure to access one of or both of these additional reports for tough credit decisions.

Next, look into the prospect’s Blue Book rating and credit score. A good rating and higher credit score indicate greater creditworthiness and a lower risk of delinquency or going into default.

3) Financial Statements

Reviewing financial statements provides insights into a company’s financial health. Important documents to analyze include: a balance sheet (shows the customer’s assets, liabilities, and equity); income statement (details revenue, expenses, and net income); and cash flow statement (tracks cash inflow and outflow).

These documents outline liquidity, solvency, and performance, and offer necessary insight into whether a prospect has a solid financial foundation and should suggest whether or not it will be able to pay its debts. 

Buyers often share their financial statements with Blue Book—check to see if the company has a credit worth rating. If it doesn’t, request prospects share financial statements directly with you or with Blue Book. 

Financial data shared with Blue Book is in the strictest confidence, used for rating purposes only.

It’s unfortunate, but yes, we live in a time when we must not only conduct a background check on a new prospect but research its references too.

4) Trade References

Contacting trade references helps verify the prospective customer’s payment behavior with other suppliers.

Key questions to ask include: Does the customer consistently pay on time? What credit terms were extended to the customer, and were they adhered to? How has the overall experience been in dealing with the customer?

Be sure the references are real and not fraudulent. The produce industry has seen a rise in impersonation fraud in recent years.

Look closely and validate the contact information of each reference.

It’s unfortunate, but yes, we live in a time when we must not only conduct a background check on a new prospect but research its references too.

5) Bank References

Bank references provide additional insight into a customer’s financial stability and legitimacy.

When contacting banks, inquire about account status (are accounts in good standing?); credit lines (does the customer have existing credit lines, and if so, and are they well managed?); and financial health (an overall assessment).

Banks do not often share detailed information during such inquiries, but should be able to at least verify if the prospect has an account there.  

6) Industry and Market Conditions

Understanding the industry and the market conditions under which a customer operates will help gauge its potential for success.

Consider factors such as industry trends (analyze growth trends, challenges, and opportunities within the industry or region where the business operates); market demand for the customer’s products or services; and the competitive landscape (assess its level of competition and define any advantages).

Knowing where your product is going is important; economic conditions could present a red flag to doing business.

7) Payment Terms and Conditions

When extending trade credit, payment terms and conditions must be clearly defined.

First, set a credit limit based on the prospect’s financial health and creditworthiness. Next, specify payment terms, such as net 30 days. Also outline penalties for late payments to encourage timely pay.

Clearly outlining expectations is always best practice when beginning a new relationship.

8) Monitoring and Review

It’s important to regularly monitor accounts and review a customer’s credit status to ensure ongoing reliability. This includes conducting periodic reviews of the customer’s financial statements and payment patterns.

Over time, it may be necessary to revise or adjust a customer’s credit limit, based on performance, financial health, or economic factors.

Lastly, promote and maintain open communication with all customers. This will help prevent issues and allow you to deal with them as quickly as possible when they do arise.

Concluding Thoughts

Evaluating potential or new customers for trade credit involves a thorough analysis of their credit history, financial statements, trade and bank references, industry conditions, and payment terms.

This comprehensive approach ensures credit is extended to customers with the best potential for reliable and timely payments, contributing to the overall financial stability and possibly growth of both businesses.