Five credit checks you must make on new customers

As a new business, it’s natural to feel overjoyed at your first sales. Customer validation of your idea is essential if your start-up is to succeed.

However, how much do you know about the customers who buy your products and services? Are they tardy payers? Is their business teetering on the brink of collapse? Are they operating in a cash-constrained market?

Unfortunately, many new entrepreneurs fail to make these sort of queries, through lack of time or know-how. The result is that countless small businesses suffer from late payment and problem customers.

“Not all money is good money,” says Moses Samaha, head of commercial risk at Veda. “You may think it’s too hard to follow a checking process, but it is time consuming and irritating to chase money. Every business has a late payer and it’s very draining.”

Samaha says common mistakes include not looking into the background of the directors of debtor companies, rather than just the businesses themselves, as well as the unquestioning acceptance of longer payment terms.

Finding out if your customer is going to be more trouble than he or she is worth can be tricky if the business isn’t listed. But there are ways of doing it, says Samaha.

“Talk to your peers in your industry, get references and ask your customer for their bank statements and P&L,” he advises. “If you’re dubious, get director guarantees or bonds. You need them to have skin in the game.”

“Small business owners are very emotionally attached to their businesses, which can blind them to good business practices. You need to be careful with new customers.”

With this in mind, Samaha has put together five top tips on how to check if your potential customer is going to be reliable or a dud.

1. Character

Research the people behind the organisation you are dealing with. It’s important to assess a person’s willingness to pay, based on their overall attitude, their company values and the financial track record of the business and its leaders.

Check for any signs of a dark financial past. Factors such as past defaults or court actions can give important insight into the financial and ethical standards behind the people running the business.

2. Capacity

Assessing the prospective organisation’s capacity to generate sufficient cash flow to cover any outstanding debts should be the highest priority of any credit manager. This is critical before investing in a company or extending a large amount of credit.

3. Capital

Understand your customer’s capital base, including their cash and other assets, as well as shareholder commitments. This is important to ensure credit has not been extended to an organisation that can’t afford to repay their debt.

4. Cashflow

This is the “lifeblood” of any business. Poor credit control will greatly affect cashflow and the ability to pay debts on time, so it pays to develop an understanding of the financial situation of the business to which you are extending credit.

This will give you an indication of how swiftly they may pay you for your products or services and the likely impact on your company finances.

5. Conditions

The current economic conditions in each marketplace may affect the ability of a business to repay debt on time, which may require adjustment of your credit policies.

Consider factors such as the impact of international economic conditions on the domestic market, such as offshore financial volatility and fluctuating exchange rates, as well any changes in the political landscape. Is the prospective customer susceptible to economic downturns?