Bank of America Merrill Lynch White Paper Questions to Consider Before Extending Credit Executive summary If your business is considering a credit program, it s important to start out with a firm understanding of the basics, from credit terms to collection best practices. Managed properly, extending credit to your customers can serve as a critical strategy for future growth. Contents Understanding risks and rewards.... 2 Gaining additional business and obligations... 2 Setting limits. Mitigating risk.... 2 Know your legal obligations... 3 Timely payment strategies... 3 Collection best practices... 4 Relying on relationships... 4
QUESTIONS TO CONSIDER BEFORE EXTENDING CREDIT 2 Understanding risks and rewards Attractive credit terms can spark an increase in sales to consumers and business customers, support upselling initiatives by allowing them to budget for bigger purchases, and strengthen customer relations. Before business owners extend credit to customers, they need to understand the risks relative to the potential benefits. That s especially true in challenging economic times but in any economic climate, credit extension and oversight require a commitment of time and attention that some small business owners may not be able to divert from running their companies. To assess the net benefits that credit extension may offer to your business, begin by learning what credit terms are customary in your industry; terms vary from one industry to another. Trade associations are good resources for getting grounded in the basics. Once you know how credit extension will need to be structured for your business, the next step is to assess whether and how it will strengthen your value proposition and ability to compete in your market. A company that offers a unique product or service for which there is high demand won t need to offer credit to attract customers or clients and achieve growth in market share. Conversely, a well-capitalized company that s selling a commodity in a competitive industry may find that credit extension can generate an increase in market share. Gaining additional business and obligations How many additional customers, and how much additional business, can the company gain by offering credit extension and what business will the company forgo without it? You make that evaluation, and you determine whether you have to offer credit or not, says Bob Seiwert, senior vice president of the American Bankers Association. If so, are you going to offer it on the normal terms of the industry, or are you going to use it as a competitive tool and gather more customers and offer looser terms? Before business owners extend credit to customers, they need to understand the risks relative to the potential benefits. He cautions business owners to recognize the real cost in the latter approach, which will make the company more attractive to slow-pay clients. So you d better be pretty good at evaluating credits, which may not be the forte of business owners. They re so busy running their business. They don t have time to focus on the creditworthiness or know how to evaluate the creditworthiness of customers. So you ve got to figure out how this fits in the game plan. Setting limits. Mitigating risk. Another policy question is how much credit your company will extend to any one customer or to customers within a particular industry. The answer to that question depends on risk assessment: how much the company can afford to lose. Among the questions Seiwert encourages business owners to consider: How much do I have to extend credit to be competitive? How much exposure can I have? And if I take a hit, will my business survive?
QUESTIONS TO CONSIDER BEFORE EXTENDING CREDIT 3 One strategy for mitigating risk is establishing a payment schedule. However, in some circumstances, you may agree to extend terms in line with a customer s seasonal business. In that scenario, Seiwert advises that your company must make sure it is paid when the customer is paid. Any time you wait longer than that, you re really putting yourself at risk, because there are lots of demands for that money, he says. If you re going to offer dating terms, you want to time the extension of credit and the payment of credit to when that customer is going to be receiving the cash from their customers. That s critical. Another challenge, particularly for small businesses with limited staff resources, is monitoring the financial health of the customers to which they ve extended credit. One way you limit your exposure is by limiting the amount of credit you extend, Seiwert says. But you better keep your ear to the ground by joining trade associations, the chamber of commerce the rumor mill can be very beneficial. You ve got to be attuned to the grapevine. Know your legal obligations You definitely need a lawyer to write up your sales contracts, Seiwert stresses. Your trade association, accountant and business banker can direct you to additional resources. It s also essential to familiarize yourself with Federal Trade Commission (FTC) regulations, as well as consumer and business lending laws. The FTC s Bureau of Consumer Protection Business Center provides business owners with advice regarding credit and loans, payments and billing, and debt and debt collection. Resources on its website also include the Complying with the Credit Practices Rule guide and advice regarding the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Fair Credit Billing Act, the Fair Credit Reporting Act, and the Fair Debt Collection Practices Act. Debt collection presents an ongoing challenge for small business owners who extend credit to their clients and customers. Timely payment strategies Debt collection presents an ongoing challenge for small business owners who extend credit to their clients and customers. Some of those challenges arise due to inefficiencies on the creditor side. Short of staff and in the middle of a marketing push, small companies can fall behind on invoicing, which can lengthen the pay cycle or create a billing pile-up that leaves the customer with a charge that s too big to dispatch in a single payment. Competing priorities can also lead to delays and deficiencies in following up on delinquent accounts. Many of these problems can be averted by establishing good invoicing and debt collection practices in advance. We make sure that we re using all of our tools and all of our strategies in order to do what s necessary to recover and enforce the debt. A lot of people don t enforce the debt. They do collections somewhat maybe a letter, maybe certified mail, maybe a few
QUESTIONS TO CONSIDER BEFORE EXTENDING CREDIT 4 phone calls and then they give up, says Stephanie Williams, vice president of collection operations at Freedom Stores Inc., and a former member of the board of directors of ACA International, the Association of Credit and Collection Professionals. If you have certain standards and tools in place, and you re enforcing the debt and also counseling the consumer, I think you would be a little bit more successful. Collection best practices Credit and collections experts agree that if you haven t established a payment expectation before the bill is due, you re already a step behind. Best practice calls for stating terms at every step of the transaction. Include the payment terms on the price quote. Restate the price and terms on the confirmation of receipt of the purchase order. Include the payment due date on the invoice. Offer the option, positioned as a convenience to the client or customer, of sending a reminder by email or text five days before the due date. Credit and collections experts agree that if you haven t established a payment expectation before the bill is due, you re already a step behind. It s all part of what Williams calls enforcing the debt, and it begins by qualifying clients and customers, and making sure they understand the credit terms and repercussions of non-payment before the company extends credit. Tim Collins, an ACA International member, and attorney who has worked in the debt collection industry since 1993, underscores this point. He is director of compliance at Hyundai Capital America, which sends a welcome package to new customers a tactic whose benefits extend beyond building goodwill. Mail that s returned as undeliverable gives the company an early opportunity to update its records so that billing can be sent to a correct and current address and raises an early red flag about customers who may be a bad debt risk. The company also makes follow-up phone calls to new customers in the higher risk account pool, such as people with lower credit scores. The conversation offers a friendly welcome and asks if there s anything the customer needs but it also provides an opportunity to collect additional phone and other contact details that may be useful should a collections need arise. Relying on relationships That s one illustration of the extent to which good credit collection practices go handin-hand with relationship building. That can be true even when it becomes necessary to initiate collection calls to a customer who is having trouble making payments on time. Small businesses, in particular, are likely to have personal relationships with their clients and customers, and Williams advocates trying to work with late payers to set up payment plans. We can offer a payment plan, but we can also refinance them or offer them a lower payment for a little bit longer term. So there are different ways that you can do it, but you have to educate, you have to listen, and you have to make them understand that we re helping you, and in order for us to help you, we re going to take a little bit of a loss in the beginning, but we re going to make it work out, she says. From that point, you always communicate. I always tell our customers, don t ever not call us.
QUESTIONS TO CONSIDER BEFORE EXTENDING CREDIT 5 That outward show of support can also be turned on its head to pressure customers to meet their obligations. Small business owners can express sympathy for the personal or business problems that have caused the payment delay and then remind customers that they don t want to compound those problems by having their credit ratings damaged. At that point, a friendly demand for payment is couched in terms of concern. That s perfect, Collins says. It puts you on the same side as that customer. Above all, don t delay in acting on delinquent payments. You have to start right away. The older the debt gets, the harder it is to collect, and that s true for anyone, Williams says. The same is true, she adds, of selecting a collections agency to pursue accounts from which your business has failed to receive payment. It takes time to do background research on agencies, ensure that they re properly licensed for the states in which you need them to operate, and know which techniques they use in their collection process. Here, again, your company needs to complete that groundwork before it needs those services. You have to start right away. The older the debt gets, the harder it is to collect, and that s true for anyone. Stephanie Williams Vice President Collection Operations Freedom Stores Credit extension is a complicated business that can place heavy demands on small companies but in the right circumstances, and with proper management of these concerns, it can serve as a tool for sales growth. This article is for informational purposes only. Please consult your tax advisor, as neither Bank of America, its affiliates, nor their employees provide legal, accounting and tax advice. Bank of America Merrill Lynch is the marketing name for the global banking and global markets businesses of Bank of America Corporation. Lending, derivatives, and other commercial banking activities are performed globally by banking affiliates of Bank of America Corporation, including Bank of America, N.A., member FDIC. Securities, strategic advisory, and other investment banking activities are performed globally by investment banking affiliates of Bank of America Corporation ( Investment Banking Affiliates ), including, in the United States, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp., both of which are registered broker-dealers and members of SIPC, and, in other jurisdictions, by locally registered entities. Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch Professional Clearing Corp. are registered as futures commission merchants with the CFTC and are members of the NFA. Investment products offered by Investment Banking Affiliates: Are Not FDIC Insured May Lose Value Are Not Bank Guaranteed. 2014 Bank of America Corporation 10-14-0066