Credit Evaluation Is Important
After a credit department’s mission has been outlined, the specific goals to accomplish the mission have been drafted, and the organization of the department has been set, the credit department can finally start doing work. Central to the function of the credit department is credit evaluation. Evaluating the credit worthiness of a potential credit customer in an efficient, repeatable, and accurate manner helps to minimize credit risk/exposure, protect margins, and maximize profits. The first step, and where much of the work is accomplished, is through a good credit application.
A Thorough Credit Application Is The Best Way To Evaluate Credit
The first step in managing credit wisely is to make informed decisions about which parties should qualify. Standardizing the credit process by having every potential credit customer (which may be every customer) fill out a credit application helps to create a standardized risk-mitigation procedure. The first step in managing credit wisely is to make informed decisions about which parties should qualify, how much credit they should be extended, and the terms thereof. Depending on the information in the credit application, the payment terms may be modified, or some customers may not qualify for credit at all. While it may hurt to turn down a sale if the results of the credit application don’t meet your policy requirements, the actual cost of a non-paying client is much higher than the amount of the lost sale.
As well as contacting the credit references listed in a potential customer’s credit application, it can be a good idea to run a credit report. There have been several previous posts on the Construction Payment Blog documenting important parts of credit applications. But, at the least, credit reports provide a nice snapshot to help make credit decisions, and should be a standard part of a proper credit application.
Information to be included on the credit application may include:
- Contact Information
- Credit Information — Credit Report of the business (and potentially of the owner as well) should be pulled (obviously dependent on the potential customer). To accomplish this you will need an EIN for the business, and an SSN from the owner.
- Landlord and/or Mortgage Holder References — If the business doesn’t pay their rent or mortgage on time, you likely won’t get paid on time, either.
- Bank and/or Trade References — Same thing applies here. A clearer picture of the customers financial picture appears with every new piece of information.
- Payment Terms — You may wish to outline your general payment terms in the credit application itself, clearly, though any potential modification to the general payment terms would then need an additional signed document. You may wish to keep the two separate, as well. Once a credit decision has been made, the terms can be set and agreed to in a separate document.
- Personal Guarantee — A personal guarantee added to the credit application gives you an added layer of security, and potential collection tool. Nobody extends credit to a company that they think won’t pay, but the personal guarantee of the business owner (or contracting party) can sometimes provide an extra push to receive payment. Note, however, that this is likely not an option, (nor would you generally want to include it) when dealing with a larger potential credit customer.