Businesses don't operate in a vacuum. It's virtually impossible to develop, manufacture, produce, and ship the final product that an end user purchases completely in-house.
There are multiple manufacturers and/or suppliers that adopt one, or all, of the roles so a company can sell its product to their customers.
Simply put, companies likely need to purchase goods and services from their manufacturers or distributors, but may lack the capital or an established credit history to do so. In this case, the manufacturer or distributor -- that is, the seller -- needs to conduct the necessary credit due diligence prior to issuing credit terms to their customers.
After all, blindly signing a sales contract with credit terms can increase a seller’s credit risk, and ultimately cause delinquent or default payments.
So, here are six ways to reduce your credit risk as a seller.
Prior to signing any agreement, it’s worth considering buying a credit report with a credit score from a bureau.
This report provides important information regarding the company's corporate details (e.g., date of incorporation, identity verification, and more), credit payment and financial history, banking statements and reports, bankruptcy history, and even predictive risk scores that will help you assess their creditworthiness with confidence.
This includes getting payment history from existing vendors, verifying bank account information, and even common corporate details including a federal tax ID number. A completed credit application supplements a business credit report and score. Ultimately this will help you reduce your credit risk and protect your company from any financial loss.
If buyers don’t pay your invoices on time or at all, due to an extenuating circumstance or failure at their company, this puts your company at significant financial and operational risk. After all, if your company doesn’t get paid for the materials you’ve provided, you’re at risk of defaulting on your own payments. Or worse, going out of business.
Leveraging a trade credit insurance policy will help you stabilize your cash flow.
Kimberly Kelly, Founder & CEO of Trade Credit Specialty, advises that “any company extending unsecured credit to other businesses is at risk for experiencing bad debt losses. Trade credit insurance mitigates that risk. In the event of a bad debt loss, the policy is triggered and a claim payment is made, preserving cash flow.”
A trade credit insurance policy is a cost-effective method to foster credit sales growth, gain financing support, access intelligence that can help negotiate sales contracts, and strengthen your financial statements.
It may be entirely likely that the buyer you’d like to work with has shown a hiccup in their past payment history, but has great existing and current vendor relationships. If you still want to enter into a sales contract with them, you can further reduce your credit risk as a seller by setting a credit limit and building it directly into the Terms and Conditions contract with your lawyer.
In order to set a specific credit limit, learn as much as you can about the buyer, evaluate the company’s net worth, and even calculate the day sales outstanding (DSO), which determines the company’s efficiency at being paid. By setting a credit limit for your buyer, you can decrease the chances of being severely impacted by a late payment or even a default.
You can always set cash-upfront terms for the first year, and then later offer them credit.
Michael Dennis, a credit analyst and the author of books including “Credit and Collection Handbook,” stressed the importance of bulletproof language and payment terms that don't have any wiggle room. "The only way payment terms could ever be changed would be as the result of a written agreement signed by both parties," Dennis said.
Once a potential buyer is assessed and their credit application is approved, it can be too easy to forget about them and move your attention to the next new potential buyer. However, if an existing buyer undergoes a financial problem in the middle of an ongoing business relationship, you may not realize it until it’s too late.
“In reality, creditworthiness changes every day,” said Andriy Sichka, Founder and Managing Partner of Swiss company Credit Engineering. “And those who don’t pay attention to this put themselves in a very weak position. So, stay on the safe side. Monitor your customers regularly.”
Therefore, at Nectarine Credit, we recommend conducting ongoing credit reviews of all your buyers annually, at minimum, to ensure that the initial sales contracts and credit terms don’t need to be adjusted and that your business isn’t at financial risk.
The credit analyst Michael Dennis agrees with this sentiment for the potential of this ongoing credit risk.
Over time a new customer’s financial position will have one of three outcomes: improve, stay about the same or deteriorate, Dennis said. “If you only evaluate creditworthiness once, you ignore the third possibility and the risks it creates.”
One of the best ways to reduce your credit risk is by simply building a strong relationship with your buyer. Over the course of any company’s lifetime, there may be trying times that can impact its ability to fulfill the contractual obligations agreed upon initially. After all, the recent Covid-19 pandemic has demonstrated how easily materials shortages can impact the global supply chain.
So, during challenging times, if you’re more empathetic towards your third-party provider and work with them to come up with a solution, you’ll foster a strong relationship over time you can rely on.
On the other hand, if you have a solid relationship with a buyer (i.e., they have consistently paid on time and in full), you may reward them by providing discounts on larger orders as a sign of good faith and show gratitude.
And you may consider extending their credit terms to remain competitive.
As noted above, filling out a credit application is an integral part of assessing your risk prior to signing an agreement with a new third-party manufacturer or distributor. However, many companies still rely on traditional Microsoft Word documents or PDF templates to complete the credit applications.
By using a digital credit application software like Nectarine Credit, you can streamline the entire application process. You’ll be able to conduct automatic vendor reference checks to reduce delinquencies, manage all your credit applications in one dashboard to reduce the credit approval time, and verify bank accounts that include cash flow reports.