Establishing a trade credit policy
When shopping in Morrison’s, you don’t take a full trolley of goods to the cashier and ask them to stick it on your tab. You have to pay for your items there and then in order to escort them off the premises—or you’d be accused of shoplifting.
Within the various trades, however, there’s typically the opportunity to establish credit with suppliers of materials, for example. This is because, as a tradesperson, you won’t typically be paid for either the materials used within a project or your time until the job is finished, which means you’d be out of pocket in the meantime if you had to pay for the necessary materials upfront.
To help tradespeople, given this chain of events, many suppliers to the various trades offer credit to their customers. It’s also universally expected within the industry, which means if you don’t offer credit to your customer, you may not be as competitive as you believe against your rivals.
Offering a credit arrangement invites risk into your business; however, the interest rate applied to users of credit should be enough to mitigate this. That said, you want to set out terms and conditions that reduce such risk significantly and make it clear to new customers that your process is not open to abuse. This is what we recommend including in your trade credit policy.
Check a customer’s financial standing
If a customer applying for trade credit has racked up a string of bad debt, there’s a greater risk that they will do the same to you. Obtain access to one or more of the main credit reference agencies and consult these before you grant a credit tab to anyone. Better safe than sorry. Insist that a satisfactory credit check must preclude the signing of your trade credit policy.
Reference to references
You may also wish to acquire references from the potential debtor that give you a picture of their background. These could be from fellow suppliers concerning how the person applying for credit has conducted their account with them, or personal references (however, these can easily be forged). You may also require recent bank statements from the customer. Consider what you’re comfortable with and set this out clearly in your policy.
The application form
Ensure you capture as much vital information from the customer as you can. Gather their address and contact details, with alternative contact methods, too. It’s a good idea to merge the application form with your trade credit policy, so that the customer’s signature states their acceptance of the terms, and also that the whole form is dated/verified.
Of course, it’s not good for your business if you allow your debtors to pay you back whenever they like. Even if the project they’re working on hits a rough patch and it will take longer for the tradesperson to be paid, your goodwill shouldn’t be endless. The terms you decide upon within your credit policy, i.e. full payment within 30/60/90 days—whatever—stick to this and follow a debt recovery process if the defined time elapses and payment has not been forthcoming. State what your debt recovery process entails within your policy so that the customer is aware of all your credit terms and conditions. For instance, will they be liable for the costs incurred with chasing the debt?
Usually, it’s customary to set a limit on the amount a debtor can spend. It’s up to you if you decide to raise this limit after a period of time, once you’re confident of how reliable the customer is at paying back the money they owe you. A greater credit limit means they can spend more with you, which is good for business; however, the greater the limit, the greater the risk of their default. Perhaps you could insist on full payment of their outstanding balance before a new order is placed, or a similar measure. Ensure the credit limits you offer are relevant to the size of your own business and cash flow. And, whichever process you decide upon, add this to your trade credit policy.
The privilege of deferring payment typically comes at a cost for the customer, namely in the form of an interest rate applied to the balance they owe. This is standard practice; after all, had you not given the customer their goods with the onus to pay later, you could have sold those for cash upfront—why shouldn’t you charge a fee for the benefit you’re providing? Determine the interest rate that you will charge on the amount the debtor owes, and state this clearly in your trade credit policy. Make sure you define the rate and the associated APR, and also make clear how the interest is calculated, i.e. daily, at the end of the month, etc.
If you’re unsure of any aspect, it’s wise to seek legal advice when drawing up your trade credit policy. The Consumer Credit Act 1974 must be adhered to; when a customer signs the credit application form they are entering into a legal contract with you. For this reason alone, it’s worth ensuring you’re on the right side of the law.
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