by James S. Dempster

How to Extend Credit Without Jeopardizing Your Business

 

The extension of credit is an issue to which many artists and craftspeople give little thought. Some studios take a position of extending no credit to galleries, while other artists have a rather liberal policy of extending credit to any retailer who requests it. As with many issues in life, the answer to the question of credit policy is finding a balance between these two extremes.

Extending credit terms of net 30 days, 60 days, etc., is an unsecured loan to a retailer. You are providing the retailer with your work in return for their promise to pay you. As many artists have seen in recent months, not all promises to pay are kept.

One of the first questions to ask is: “How much total credit exposure can our company afford at any one time?” Every studio has different cash flow and overhead requirements. Some businesses have a line of credit or a revolving loan with a bank that alleviates cash flow problems; other studios have no borrowing relationship and depend more heavily on prompt payment by retailers.

A second question to ask is: “How much credit exposure can our company afford with any one retailer?” In other words, what percentage of your eggs should you have in any one basket? Disproportionate exposure to one company can result in a catastrophic loss should the retailer file for bankruptcy protection.

The 4C’s of lending

Banks have traditionally viewed unsecured loans as high-risk ventures. As a minimum, banks require an evaluation of what is referred to as the “4C’s of Lending”: cash, collateral, character and capacity to repay. If you are lending to a retailer — providing hundreds or thousands of dollars worth of work to them on credit — evaluating the 4C’s would be a good policy for you as well.

• Cash. What is the liquidity of the company? You can assess the cash position of a retailer by verifying average account balances with their bank. If you are considering any significant credit exposure, you will want to verify the retailer’s banking references. (See the sample bank reference form above.)
• Collateral. What are the assets, both secured and unsecured, of the company? If the retailer’s assets are pledged to a secured lender, your claim will be considered only after the secured lender is paid.
• Character. Who are the owners and what is their background? Have they operated and closed other businesses with a loss to creditors?
• Capacity to repay. What are the company’s payment practices? Do they pay within terms, stretch terms to the limit, or even go beyond terms?

The extent of your credit investigation should depend on the amount of the order and the credit limit requested by your customer. If the customer has applied for a significant amount of credit, you may want to obtain a financial statement in order to better evaluate the 4C’s of the credit request. Financial statements explore the company’s financial position in detail — they provide information about an entity’s assets, liabilities and equity. Financial statements are confidential, and you may have to sign a nondisclosure agreement prior to receiving the statement.

A credit application will assist you in making a determination for credit extension. A credit application contains information pertaining to the legal form of business operation (corporation, partnership, proprietorship, LLC, LLP), address, telephone number, number of years in business, credit references and banking information. A credit application is very much like a loan application that a bank would require you to complete prior to extending an unsecured loan.

It can alleviate pressure on retailers at trade shows if you suggest they take the credit application with them and fax or mail it to you later, rather than asking them to spend valuable show time completing it. Many artists fear that retailers will resent being asked to fill out a credit application because that is not the way they have done business with artists for the last 20 years. Each artist will have to use his or her own judgment in certain cases, but in light of the People’s Pottery bankruptcy, this may be an opportune time to institute a new credit extension policy.

Still, many artists will resist, afraid to offend a retailer and lose potential sales. So, as an alternative to extending credit terms to a retailer, you can also consider the following means of payment:

• prepayment,
• partial prepayment,
• credit card payment,
• personal guarantee,
• cash on delivery,
• consignment sale,
• letter of credit,
• stand-by letter of credit (a payment guarantee by bank used only if needed), or
• short credit terms (e.g., net 10, 15 or 20 days).

You may use any of these methods, or a combination of them, in order to successfully complete a transaction with a retailer. You can also schedule partial shipments in order to lessen your total credit exposure. You should not, in any event, continue to ship to a retailer who has exceeded your terms of sale. In other words, if a retailer has not paid your last invoice within terms, do not make any additional shipments to them.

One of the most accurate barometers of a retailer’s credit status is its accounts payable record with other vendors. Credit references provided by the retailer generally reflect those companies that are paid within terms; it is rare for a gallery or store to provide a credit reference that is not paid promptly. The most beneficial credit in
formation to an artist is the retailer’s overall payment trend, i.e., payments under 30 days, 30-60 days, 60-90 days and 90+ days. There are interactive credit exchanges available for this purpose. You can search the Internet to find one that covers businesses in the giftware and crafts field. Membership fees and credit report costs can vary greatly.

Any credit sale involves a certain degree of risk. The objective is to minimize your company’s exposure to credit loss through slow pays, no pays, NSF (non-sufficient funds) checks, and Chapters 7, 11, and 13. The judicious use of credit can be a tremendous way to expand and manage
(Continued on page 70) your business. At the same time, a lack of attention to credit management can result in catastrophic implications for your business.

Accounts receivable … and old wine

Unlike a good wine, accounts receivable do not get better with age. One of the most frequent laments we hear from vendors is “We waited too long (to take collection action)!” There are several steps you can take internally to accelerate and improve your company’s management of its accounts receivable. By taking a few preventive steps, you can eliminate a great deal of miscommunication and ambiguity with your customers.

The first step is to prepare an accurate and complete invoice, which shows:

• the invoice number,
• date,
• purchase order number,
• bill to and ship to addresses,
• terms of payment (c.o.d., pro forma, net 30, etc.),
• f.o.b. point (free on board, which means you agree to get the shipment to a transportation point — trucking service, carrier, etc. — at no charge, and the buyer then pays for transportation of the shipment from that point),
• quantity,
• item description,
• unit price and extension amount,
• merchandise total,
• freight charges,
• invoice total, and
• applicable discounts.

Your company’s address or where to send payment should be clearly indicated on the invoice. The invoice should be mailed or e-mailed when the order is shipped. Problems reported by your customer, such as shortages, breakage, quality issues, etc., should be dealt with promptly.

If your company does not prepare monthly statements, you should consider doing so. The statement reflects outstanding invoices, back-ordered shipments,
payments, credits, etc. The statement should be sent to your customers monthly as a reminder of outstanding invoices. If an invoice does not arrive by mail, for example, the statement of account will inform the retailer that the invoice is missing.

Essential steps to collecting on debts

Regular and systematic follow-up is an important factor in collecting your accounts receivable. The first reminder notice should be sent within seven days of the date the invoice is due. For example, on terms of net 30, the first reminder should be sent on the 37th day. The second customer contact should be made within 14 days; both the first and second contacts should be by letter, e-mail or fax.

The first telephone call (third contact) should be made within 21 days after your invoice is due; the fourth contact (written) should follow at 30 days after the due date; the fifth contact (telephone) within 40 days; the sixth contact (written) should be in the form of a certified letter and sent within 45 days; the seventh and last contact, made within 60 days, should be in the form of a telephone call in which you inform the debtor that if an acceptable payment plan is not established or the account is not paid in full, the matter will be sent to collection. It is important to retain copies of all letters and to document any correspondence made with the account.

By this time, the account has been afforded an additional 60 days beyond your terms. Combined with sending a statement of account on a monthly basis, this protocol provides 10 opportunities for your account to respond in some fashion prior to invok-ing third-party collection measures. It is important to understand that the most effective internal collection measures are those that are performed regularly and systematically.

While this discussion is intended as a general guideline of credit extension and collection procedures, you may wish to modify these procedures to suit your business’s needs.

 

MARCH 2002 : TABLE OF CONTENTS