By Jim Sobeck
In most B2B businesses, the extension of trade credit is required. Most, if not all, of your competition is extending credit, so you will have to as well. Other than embezzling, there is nothing that will take your business down faster than weak credit procedures. I have seen third- and fourth-generation businesses file bankruptcy due to excessive bad debts, especially near the end of a downturn like we are presently experiencing.
Why do businesses fail at the end of a downtown and not as often in the beginning or the middle? Normally it’s because that’s when weak businesses finally run out of cash. A lot of businesses rob Peter to pay Paul; they get cut off from supplier A and go on to supplier B, and then supplier C, and so on until they finally run out of suppliers who will extend credit. It’s like a game of musical chairs, and you don’t want to be the one left standing when your customer runs out of cash.
Effective credit procedures began with a comprehensive credit application. Your credit application should contain at a minimum:
1. A personal guarantee. A lot of customers don’t want to sign a personal guarantee because they don’t want to have to pay you if their corporation fails. Without a personal guarantee, you can’t pierce the corporate veil, and if your customer’s corporation fails, you can’t collect. Do we always get one? No. Public companies will never give you one. nor will large companies with excellent credit. However, if a company has less than stellar credit, we insist on a personal guarantee unless we can get credit insurance on them.
2. An agreement for the customer to pay your legal fees if you have to file suit to get paid. You don’t want to have to pay your own legal fees, for obvious reasons. Plus, more than one customer has paid us when we have reminded them of this agreement. We point out that we use very expensive lawyers!
3. Finance charges. Unless your credit application spells out the interest rate your customer has to pay for late payment, most states won’t let you charge any finance charge. I always suggest that your agreement include the highest interest rate allowed in your state. It’s not that you want to collect on your finance charges; you want them to be a deterrent to late payment, and a high rate is a great deterrent.
4. The terms and conditions of sale. Make sure that all of your terms and conditions of sale are spelled out in your credit agreement and not just on the back of your invoice. Most judges will rule that the customer doesn’t look at the back of the invoice. Also include things such as if no one is there to sign for a delivery, and you leave it at the customer’s request, but it gets stolen, that the customer is still liable for payment. Having this situation covered in your credit agreement can save you a lot of money.
Jim Sobeck is CEO of New South Construction Supply, a building products distributor based in Greenville with nine locations in the Carolinas and Georgia. He is the author of “The Real Business 101: Lessons From the Trenches.”