How Much Credit to Offer?

Your decision on how much credit to offer will be largely based on a combination of your gut instincts (is this person or company likely to pay me back?) and trial and error. A good rule of thumb is to start with a small amount of credit and make your customers earn their way to higher limits.

When we talk of determining how much credit to extend to your customers, we're usually talking about how much credit to extend to your business customers. Most of your individual customers will be paying by cash, check, or credit card. But if you sell goods or services to other businesses, they may ask you to extend a line of credit to them.

Extending a line of credit to your business customers means that you'll have two more decisions to make: how much of a credit line to extend ($200? $500 $1,000?) and which repayment terms to impose on them (30 days? 60 days? Interest on the unpaid amount? How much interest? Discounts?).

There aren't any hard-and-fast guidelines for determining how much credit to extend to your customers. But here are a few suggestions that might help you with your decision:

• Start small, particularly if your credit checking reveals that the company may be having financial problems. Depending upon what you're selling, you might start with a $100 credit line with payment to be made within 10 days. Make your customers earn higher credit limits and better terms.
• Don't assume that everyone is entitled to the same level of credit. If you're leery of a particular customer, keep the credit level low until they prove themselves to be credit-worthy.
• Reward your best customers with higher credit limits or more favorable terms. You'll come to appreciate them. Also, if you end up with some customers who don't pay on time, your good customers may be the only thing between you and insolvency.
• Don't presume that larger companies are necessarily better at paying their bills than smaller companies. In other words, don't give a company a higher credit limit or better terms than you otherwise might just because it's a "name" company. Also, don't forget that the bureaucracy at most large companies can make debt collecting an extremely time-consuming process. Of course, if you want the large company's business badly enough, you may have to give in to their payment cycle. For example, if your terms are 30 days, but the large company pays its bills on a 60-day cycle, you may be forced to accept the 60-day terms. A large company is generally not going to change its payment cycle just for you.
• Don't hesitate to reduce a customer's line of credit or shorten the terms if that customer begins to be late with its payments. If you reduce the terms, however, you must inform the company before its next purchase. You cannot inform them of a change in your policy after they've already purchased your goods or services. Thus, if you have salespeople, you should tell them about your policy changes so that they can inform the customer.
• Your credit policy should be coordinated with your business needs, particularly with your cash flow needs. You've got your own bills to pay. You need to figure out how much you need coming in each month, and your credit policy should be designed to deliver enough income for you to meet your business needs.