By Randy Myers, MSN Business on Main
Sales are important, but collecting on them is even more important — especially now that the recent recession has left many companies battling to pay their bills.
Just ask Craig Wolfe, who, in hindsight, admits that he should have known better. A new customer — an Internet retailer — was placing a big order for collectible rubber ducks produced by Wolfe’s San Rafael, California-based company, CelebriDucks. “They talked so big,” he recalls. “They were going to give us this big order, do all this bang-up business. That should have been a red flag right there.”
It may have been, but Wolfe missed it, and wound up shipping “a pretty large order” without enforcing his customary policy of requiring credit card payment from new, unknown customers. Shortly thereafter, the buyer went bankrupt, stiffing him for $1,300. And unfortunately this kind of story is not uncommon. During the first nine months of 2009, the latest period for which data are available, the number of bankruptcy filings by U.S. businesses rose 32 percent compared to the same period a year earlier, according to the American Bankruptcy Institute.
Other than requiring your customers to pay cash in advance — not an option in many industries — there is no foolproof way to make sure you never get stuck with a bad debt. The best of customers can fall on hard times, sometimes with seemingly little notice. But even in those cases, there are often clues to the impending meltdown. Spend just a little extra time looking for them — and setting up procedures to vet new customers — and you can minimize the odds of becoming a victim.
Do your due ddiligence
Start by being proactive. Require every potential new customer to complete a credit application. This form should collect basic information about the applicant — business name, years in operation, tax identification number — as well as contact information for the owner or key executive, contact information for the company’s bank, and at least three trade references (meaning businesses like yours that sell to the applicant). Ask how much credit the applicant would like, and spell out both your credit terms and the remedies you will seek if those terms are violated.
Once you’ve collected this information, verify it. Check addresses on the Internet to make sure of legitimacy. Call trade references to find out how much credit your prospective customer enjoys with them, and how long it takes to pay bills. Ask the applicant’s bank how long it has been doing business with the company, and, in round numbers, the size of the company’s checking account balance, credit line and available credit. To improve your odds of the bank cooperating, include a sentence on the credit application authorizing the bank to provide this information.
If the prospective customer is a publicly traded company, you can review its financial statements at its Web site or at the federal government’s free Web site, EDGAR. Look to see that there is nothing alarming in your prospective customer’s revenue and profit trends, that its receivables aren’t growing out of line with sales, that its cash flow is sufficient to comfortably cover its debt payments, and that it’s in conformance with any loan covenants imposed by its banks or other lenders.
If your prospective customer is privately held — and the amount of credit it’s requesting justifies it — you can ask for a copy of its latest financial statements. You also can purchase a credit report on the company from Dun & Bradstreet, the biggest and oldest provider, or one of its newer competitors, such as Kroll Factual Data or Cortera Inc. Kroll combines data from a variety of credit reporting services in its reports and assigns each company in its database a risk score. Cortera supplements its core data with input from its online community of users.
M.H. Hanley, vice president of strategy for The Tile Doctor, an Atlanta, Georgia-based company that sells sealers, cleaners, cutters and other accessories used in the flooring industry, says her company buys credit reports on prospective customers from Kroll at a cost of $19 each.
Hanley says that about 50 percent of the time those reports give her everything she needs to decide whether to extend credit. When they don’t, she or one of her colleagues contacts the company’s trade references. Over the past several months, she says, this routine has led her company to deny credit to three potential customers.
Keep tabs on existing customers
Carefully vetting new customers can weed out some credit risks, but it won’t guard against existing customers going bad. For that reason, Alex Coté, vice president of marketing for Cortera, recommends that you review your customer accounts regularly. Watch for any customers that start taking longer to pay their bills, of course, but also for any that dramatically boost the size of their orders, which could indicate they have already burned bridges with your competitors. Also beware of customers that are initiating more payment disputes, taking more deductions, or returning more of their purchases.
Beyond parsing statistics, pay attention to the people who actually place orders with your firm, Coté says. If your usually chatty contact stops talking or is terminated with little or no explanation, it might portend bad news.
If you do spot something suspicious, contact your customer for an explanation, and if the company does enough volume that its failure would jeopardize your cash flow, fall back on the basics. Buy a copy of its credit report. If that doesn’t satisfy you, request a visit to review its financial statements. “It’s a tough ask, but it’s reasonable,” Coté says. “And sometimes it’s the only way to know what’s going on.”
Coté also suggests calling your competitors to find out what they know about your mutual customers.