Does your company operate in the business-to-business (B2B) marketplace? If so, you’re no doubt aware of the double-edged sword that is customer credit.

On the one hand, it’s common practice. Most customers likely expect to be offered a credit option when engaging in B2B transactions. On the other, credit arrangements inevitably come with risk of late payments or nonpayment, which can lead to cash flow problems for you.

To manage this risk, it’s critical to keep a close eye on how your B2B business is handling customer credit. A good place to start is at the beginning — with credit assessment.

Gather the pertinent data

Presumably, you already ask new customers to complete a credit application. If you’ve been using the same form for a while, reevaluate it to see whether you should add questions or update the design. The application should request basic information such as each customer’s:

• Business name,
• Physical address and website URL,
• General phone number and email address, and
• Employer Identification Number for tax purposes.

Bear in mind that you can request additional specifics. For example, perhaps inquire into how long the business has been operating, under what entity type it operates and whether it has a parent company.

If the company is privately owned, consider asking for a set of its most recent financial statements — or, at the very least, its latest income statement and balance sheet. (Financial statements of publicly owned businesses are published in their annual reports.)

On the income statement, analyze financial data such as after-tax profit margin, which can be calculated by dividing net income by net sales. Ideally, this metric will have remained steady or increased over the course of the year. The company’s profit margin also should be similar to that of other businesses in its industry.

From the balance sheet, you can determine current ratio, which can be calculated by dividing the company’s current assets by its current liabilities. The higher this ratio is, the more likely the business will be able to cover its bills.

Check references … and more

Along with the information mentioned above, references are key. Ensure someone on your staff is following up on these.

Begin with the company’s bank reference to learn or verify its checking and savings account balances, as well as the amount available on its line of credit (if it has one). Find out whether the business has recently violated any of its loan covenants.

Next, contact multiple trade references for the company. Establish the length of time that each reference has worked with the potential customer, as well as the approximate size of each of the accounts. Also inquire about the potential customer’s payment history with each reference.

In addition, order a credit report on the business from one of the major credit rating agencies. The report will describe the company’s payment histories with various creditors and reveal whether it has filed for bankruptcy or had a lien or judgment against it.

Last, consider using “adverse media screening” in your due diligence process. This is when a prospective borrower is “screened against” various media sources to determine whether the person or entity has been a party to any suspicious, unethical or illegal activities. It can also reveal worrisome news, such as stories about impending lawsuits or plans to shut down a division.

Improve the odds

As a B2B company, you don’t have to accept customer credit problems, and the resulting negative cash flow impact, as a “cost of doing business.” By continuously improving your approach to credit assessment, you’ll stand a better chance of avoiding unreliable payers. We can help you review your process and choose the optimal metrics.

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Polk & Associates

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Polk and Associates is a member of the Michigan Association of Certified Public Accountants, and the American Institute of Certified Public Accountants. The firm participates in the AICPA Peer Review Program, and has always received the highest level of award for its audit practice and quality control.