Advantages & Disadvantages of a Liberal Credit Policy
Every small-business owner needs to decide whether or not it is in his best interest to start taking customer payments on a credit basis. While dealing with cash only is certainly the easiest and quickest way to get paid for goods or services, in today’s fast-paced and electronic world many commercial customers are using credit for payments. This includes whipping out the corporate credit card or buying supplies on a monthly line of credit with vendors.
Whether or not the pros and cons of a strict credit policy are worth the investment and hassle is up to you, but it's worth at least knowing the advantages and disadvantages of credit sales.
It’s important to remember that when you extend a line of credit, you are receiving a promise to pay at a later time. This exchange is simultaneously one of the advantages and disadvantages of credit sales.
The obvious and inherent risk in extending credit is that the customary may theoretically never pay up. One of the advantages of a credit policy, however, is that it creates a written (and enforceable) paper trail. Because of this, you should run it by your attorney before making it law.
Credit limits. The first thing you’ll want to determine is how much credit to extend to each customer, and in what form. Credit by any form is a financial risk to you and your company’s financial future, so it’s important to establish dollar figures for the amount of credit you’re willing to extend and define the parameters or circumstances of its payback.
Credit terms. This is the section that determines when the customer’s payment will be due, and whether there will be any discounts for early payment on the account – or late fees attached should the customer fail to pay on time.
Deposits. You may not wish to extend full credit to some or all customers. Therefore, you may want to consider requiring a deposit on orders so that you can be assured to at least get a portion of the amount due in advance. Knowing that some of their money is already invested in the transaction can help keep customers accountable.
Credit cards and personal checks. It’s one thing to extend a cash credit line with a well-known and established client or customer, but quite another to start accepting personal or commercial checks and credit cards. With these forms of tender, you are no longer dealing directly with the customer, and in the event of a dispute you may need to deal with the bank in order to get paid.
Check with your bank about your credit card merchant status and to set policies regarding the acceptance of personal checks.
Customer information. It should go without saying that before you extend any credit to a customer, you should know as much as possible about the person or company and their financial situation before doing so.
Some of the most typical things you’ll want to know are years in business, length of time at present location, financial data, credit rating with other vendors and credit-reporting agencies, information about the individual principals of the company, and how much they expect to purchase from you.
Documentation. One important piece of a strict credit policy is the aforementioned paper trail that you’ll generate, which includes credit applications, sales agreements, contracts, purchase orders, bills of lading, delivery receipts, invoices and any other correspondence.
This shows proof of the transactions with the customer, as well as any promises to pay credit back at a predetermined time and pace.
Payment in different currencies. One of the advantages of a credit policy that accepts electronic forms of payment such as credit cards is that the math is already done for you. Currency transfer is usually quite easy, as the payment to you will be in U.S. dollars while the person making the purchase will get charged in their own currency.
This makes it easier to accept payment from people in foreign countries or visiting tourists.
Ease of use. Using electronic forms of credit are extremely easy these days with the advent of such point-of-sale technologies as Square and Apple Pay. For services such as Square, when you sign up the company will supply you with a point-of-sale card reader that can be set up very quickly.
Also, with phone apps such as Venmo, Zelle and countless others that allow instant online payment transfer, the days of needing a cash register are long gone.
Customers more likely to spend more. Studies show that people are much more prone to overspending and making impulse purchases when they have a form of credit in their wallets as opposed to a wad of cash. Psychologically, it’s much more difficult to watch cash disappear.
While some customers will always prefer to deal with cash, one of the advantages of a credit policy is that you open yourself up to a whole demographic of customers who will be more willing to pay for your goods and services if you accept credit.
Convenient recordkeeping. That paper trail you’ve been trying to keep on your customers becomes much easier when you have an itemized list of credit transactions your bank can provide on monthly statements. When it comes time to balance the books and pay taxes, most customer transactions done through a bank can be easily downloaded to financial programs such as QuickBooks and FreshBooks.
The cost of cash discounts. You may offer discounts on your services to entice customers to spend their money with you by paying cash only, or for early payment on their credit accounts. While the tactic may in fact bring in more business, you run the risk of losing money if too many customers take advantage of your generosity. It’s a gamble, and you’ll have to decide if the payoff is worth it.
Dealing with bad debts and potential fraud. If a customer fails to pay on their credit accounts, or even worse, defaults or goes into bankruptcy, you may have to write off that loss, eating into your potential profits.
The same thing can occur if a bad actor uses a stolen credit card to make a fraudulent purchase at your shop; most card companies won’t hold customers liable for those purchases.
Transaction fees. The ability to accept credit payments and use point-of-sale technology can have its disadvantages as well; while it’s easy, it’s not cheap. Most services will charge your business a fee, usually about 3%, to accept credit card transactions, which can add up for a small business.
Complicated accounting. If your business is large, or you accept a large number of credit accounts, you could be in for a lot of paperwork and the need for more staffing to handle your accounts. You may need to hire people to deal with sales, accounting and collections to track down late accounts or handle legal issues stemming from non-payment.
Loss of goodwill. While accepting credit can attract good customers, the need to constantly hound a late-paying client can make for a stressful situation. Everyone falls into tough financial times, and while no one wants to repeatedly ask for payment or charge late fees, it’s a part of business. You’ll have to decide if repeat business with a late-paying customer is worth the hassle.