Establishing Creditworthiness

It could be said that the purpose of credit management is to acquire good business for the company. The front end of this process is to check potential customers for creditworthiness before deciding whether or not to accept or reject them on a credit basis. Credit checking, however, should not be seen (or used) as a means of weeding out all potentially unsuitable customers - after all, you want your business to grow. Rather it is an assessment of how big a risk you would expose yourself to were you to accept the customer, and how much you are prepared to chance.

Example

A customer to whom you would not grant monthly credit of £2,000 might be good in the first instance for £500 - after that, if the business relationship proves to be sound and profitable, you might increase their credit limit on the strength of their account history with you. Alternatively, if they do not pay, you might stop their account, but bearing in mind their credit limit was set at £500 and assuming your terms are net 30 days, good credit control should limit your exposure to £1,000. Giving them the higher credit limit would have meant a risk of £4,000, or more, if credit control was sloppy.

Consumer credit checking

The most common form of consumer credit checking is to use the services of a credit reference bureau. They keep records including county court judgements from the previous six years (normally), electoral roll registration, and account information from member companies. Consequently you can find out if your prospective customer has ever been taken to court for non-payment, if they paid any summonses they received, if they are registered at the address they gave you, and how promptly they pay their other accounts. (The account history information typically relates to store cards, credit cards and mail order agreements, such as those made with catalogues, book clubs, etc.) The charge for a check is normally a few pounds, and whilst it will not tell you if you should accept or reject a potential customer, it will provide you with information to help you make an informed decision.

If you plan to offer credit facilities or hire out equipment in excess of three months to consumers, you will need to apply for a licence under The Consumer Credit Act 1974. There are some exceptions, but if you think you may be affected by this Act, contact your local Trading Standards Officer. It is a criminal offence to trade without a licence and debts owing will be unenforceable. There is often a delay in getting a licence, and you can't offer consumer credit without one, so apply promptly.

Trade credit checking

Credit checking potential trade customers may be more complicated. You need to compile sufficient information to allow you to build up a picture of the customer and the state of his/her finances. To do this, you need to request information from third parties. The most common sources of information are:

• bank references;
• trade references;
• information from competitors;
• credit reporting agencies; and,
• company information.

Bank references

Whilst you can normally rely on the opinion of the customer's bank for accuracy, you may have to translate their opinion from 'bank speak' into English! Phrases they may use include:

• 'undoubted' - have no fears about the creditworthiness of this customer;
• 'respectably constituted', 'good for your figures' - this customer is a good risk;
• 'we do not think he would enter into ...' - be careful, weigh this up carefully in the light of other information you can gather;
• 'capital fully employed' - the customer is heavily committed financially already; and,
• 'we regret we are unable to speak for your figures' - we have serious reservations about the financial situation of this customer.

When you request a bank reference, you must be specific so that the bank know what it is you are asking. They would be hard pushed to offer an opinion on a request that read, 'Is Company A good for trade credit?' However, if instead you were to ask, 'Is company A considered good for trade credit of £1,000 per month on 30 day terms?', you would be more likely to get a useful reply as you have given the bank a figure to use in their assessment.

There is normally a charge for bank references. You ought to be able to reduce this, however, by writing direct to the prospective customer's bank but inviting them to reply via your bank, whose details should be included in your letter of enquiry (they will not reply direct to you). The alternative is to get your bank to handle the entire enquiry on your behalf.

Trade references

Whilst it is unlikely that someone will give you details of a trade referee (someone with whom he already has an account) who would give a bad reference, it can still be useful to pursue this information. A word of warning - if you do not recognise the name of the referee, check it out to see that it is a genuine company. Also, you should make it easy for the referee to complete your reference form and reply - busy people will not go to a lot of trouble to provide you with information following an unsolicited enquiry.

Your trade reference form should be straightforward, with short answers or tick boxes to be completed. Questions could include:

• How long has the subject been known to you? Include spaces to fill in the number of years or months;
• How much do you normally allow on credit? Include a '£' sign with a space after for the figure;
• What terms are allowed? Here you could leave a space for terms to be filled in, or provide a list to be deleted or ticked as appropriate, including, for example, 'weekly', 'fortnightly' and 'monthly';
• Are payments made regularly and to terms? 'Yes/No', for referee to delete as applicable; and,
• Have you any other comments you would like to make? Leave a space for the response.

At the bottom add a place for the referee to sign, along with a disclaimer along the lines of: 'This information is given in the strictest confidence and without responsibility on our part'.

Information from competitors

Some specific industries have established credit groups to share information; you should find out whether or not one exists in your field. That aside, it is a good idea to develop relationships with your contemporaries - your customers may well be their customers, and the opportunity to share information is not to be missed. As well as finding out if a potential customer appears to be a good risk, you could also be tipped off if a customer looks like they are in trouble.

Credit reporting agencies

For larger companies, you will be able to conduct a search through, for example, Dun and Bradstreet.

Company information

If you require more information, or if you feel the information you have amassed is contradictory or inconclusive, you could always ask to have a look at your prospective customer's balance sheet. At the end of the day they must file accounts with the companies' registry by law, so have nothing to lose by disclosure. Naturally, any information you are given must be treated in the strictest confidence.

In all cases, ask yourself if a credit check is really necessary; a one-off sale of, say, £200 is unlikely to necessitate a credit check, although a request for monthly credit of, say, £500 or more probably would.