Extending credit to customers allows them to purchase goods and services on credit and pay for them later on. Offering credit is often a win-win for both merchants and buyers. Customers have more purchasing power, and tend to buy more if they are not limited to cash they have at the time of the sale.
Benefits of Extending Credit to Customers
As we discussed, extending credit to customers is a way to increase sales. In some industries, like trucking and legal services, extending credit is not only common, but also expected. Extending credit is generally only practiced with companies that sell to business-to-business (B2B) and businesses-to-government (B2G) clients.
The key benefits of extending credit to customers are:
- Gain customer loyalty and a competitive edge: By letting customers pay you later for goods and services ordered today, you give your customers more control over their money and also show your trust in them. This keeps customers coming back, especially if your competitors don’t offer credit.
- Increase sales: When customers have a longer period of time to pay you back, they can purchase more goods and services from you. More buying power for your customers translates to more money in your pocket.
While extending credit to your customers has significant benefits, there are also certain things you should keep in mind when developing your credit policy. I recommend reviewing a customer’s credit history to determine whether or not you will extend credit to them and, if so, what kind of terms will you offer. You also need to put a plan in place for dealing with late payments and consider using invoicing software to help streamline the billing and payment process.
Factors to Consider When Extending Credit to Customers
Every business has customers who are more loyal and trustworthy than others. Fortunately, you are in control over the companies to which you extend credit. Some of the factors you should consider before extending credit are: what to look for in a client’s business credit report, how to set payment terms, what to include in a credit policy, and how to choose the right accounting software.
Factors you should consider when extending credit to new and existing customers are:
Customize the Payment Terms for Each Customer
If a customer has good credit and has historically paid their bills on time, chances are that they will pay you on time as well. However, if a customer has poor credit or a past history of delinquency, that should send up a red flag. A credit report will cost between $29 and $229, depending on which reporting agency you use. Check out our Business Credit Report guide to learn more about the credit agencies, how to pull a credit report, and what to look for.
After reviewing the credit report, set payment terms based on the information found in the credit report. Customers with good credit should get longer payment terms than customers who have had issues paying their bills on time.
While the industry standard is to offer Net 30 payment terms, you can choose to offer different terms. Your best customers might deserve 60- to 90-day terms, while new customers might start out with 30-day terms. Take a look at our payment terms guide to learn how to select the right terms for your business.
You can also get creative with how your payment terms are structured. Ryan Hulland, President and founder of flooring company Netfloor USA, told me a few things his business has tried for construction projects:
“We have collected a deposit before starting a project and implemented progress invoicing, which involves billing the customer each time a milestone is completed. For smaller projects, we have collected payment in full before starting a job.”
Hulland summed it up this way:
“As a vendor, you should be as flexible and accessible to your clients as possible while continuing to protect your business and your employees to make sure you grow.”
In a nutshell, you should set payment terms based on a customer’s payment history, the type of job, and the size of the job in terms of the amount of revenue it will generate.
Create a Credit Policy for Extending Credit to Customers
Before extending credit to customers, you need to have a documented credit policy in place. Your credit policy should clearly address payment terms, penalties, and interest for late payments and the collection process for delinquent invoices.
In addition, a list of acceptable payment methods, along with detailed instructions of how to remit payment, should be included. You should review the policy with your customers and have them sign-off that they agree to the terms prior to providing a product or services on credit.
A credit policy should include:
- Contact information: Detailed information on how the customer can reach you. This includes your business telephone number, email address, website, and physical address (unless you have a home office).
- Payment terms: When the payment will be due (e.g., Net 30, 2/10 Net 30).
- Interest and penalties for late payments: What interest rate or late fees will be charged and when these charges will kick in (e.g., two weeks after the due date, one month).
- Acceptable forms of payment: If you accept cash, credit or debit cards, checks, ACH transactions, or wire transfers. For credit and debit card payments and wire transfers, be sure to include instructions on how customers can make these payments (e.g., online, telephone).
- Remit to address: Include your mailing address where customers can mail checks.
- Delinquent payments: When a payment is considered delinquent (e.g., 60 days after the invoice due date)
- Collection process: What process you’ll follow to collect payment on delinquent accounts. This process may involve you contacting the customer via telephone followed up by a written letter asking for payment. It might also include engaging the services of third-party collection agencies. If you’re not quite sure what information to include in a collection letter, check out our how to write a collection letter guide for detailed instructions and a free template.
If you are still unable to make acceptable payment arrangements with customers after completing the collection process, you can report them to the business credit bureaus at no cost to you. As a last resort, you can also take them to court if you think it’s worth the additional time and cost of doing so.
Use Invoice Tracking Software
Invoicing software can help streamline the accounts receivable process. You can do things the old-fashioned way and use pen and paper or Excel ledgers. However, invoicing software allows you to create professional-looking invoices with your company name and logo, and customize the payment terms for each customer. Plus, most software programs will send you automatic reminders when invoices are coming due. As a bonus, it’s easier to stay on top of unpaid invoices by generating an accounts receivable aging report.
For a complete accounting solution that not only includes invoice tracking but a way to keep track of all income and expenses, try FreshBooks. With FreshBooks, you can create invoices, accept online payments, and run an accounts receivable aging report to stay on top of unpaid invoices. Plans start at just $15 a month and you can try it for free for 30 days.
Information Required to Meet the Qualifications of Invoice Factoring Companies
Invoice factoring is available to businesses that sell to other businesses or to government customers. You typically need to have invoices that are due in 90 days or less, a personal credit score above 530, and customers with a good payment history. Plus, you must use a compatible invoicing software like FreshBooks, QuickBooks, Clio, Wave, Harvest, and Xero.
The information you need to meet the qualifications of invoice factoring companies is:
- Invoices should be due in 90 days or less.
- Personal credit score above 530 increases odds of getting approved.
- Creditworthy customers who pay on time.
- For Fundbox, you must use compatible invoicing software.
- At least three to six months of invoicing history, so the lender can see your billing and payment patterns.
Invoice Factoring Cost
The cost of invoice factoring is approximately 2% to 5% per month. When you convert this into an annual percentage rate (APR), it comes out to be about 30 to 60% APR. While this seems very high, it’s actually cheaper than several other business financing options out there, especially if you need financing on short notice.
In addition, keep in mind that the cost of your capital being tied up in the invoices is often more than the fees charged by the invoice factor. You can use the funding to acquire inventory, hire employees, expand, or do other things that will help your business grow. Without some way to free up the cash in your invoices, you have to put your business on hold until your customers pay up.
Even worse than paying a fee is not being able to offer credit to your customers, which can make you a less profitable company in the long run. Invoice factoring is a good solution for businesses that want to offer credit to customers but need help in stabilizing their cash flow.
Pros & Cons of Extending Credit to Customers
While the pros of extending credit to customers can be quite appealing, you have to also weigh them against the cons of extending credit to customers. Increasing your sales and having a leg up on the competition is ideal. However, a delay in payment or worse—not getting paid at all—can be detrimental to your business.
Pros of Extending Credit to Customers
The pros of extending credit to customers are:
- Increased sales: Customers tend to purchase more if they don’t have to pay for goods or services upfront. This means higher sales, which can result in more profit for your business.
- Competitive edge: Extending credit to customers will give you a leg up on competitors who don’t extend payment to their customers. Customers may choose to do business with you over a competitor that does not extend credit to their customers.
- Customer loyalty: Over time, you will build trust with your customers because they know they can rely on you to provide them with the products and services they need without having the cash upfront. This can lead to a long-term and profitable relationship with customers for many years to come.
Cons of Extending Credit to Customers
The cons of extending credit to customers are:
- Delayed payment: Depending on the payment terms, there will be a delay between the time you provide goods and services and when you actually get paid. This can be as long as 30 days if your standard terms are Net 30. To mitigate this delay in payment, you can go to an invoice factoring company to get the cash you need, but you will need to weigh the cost against the benefits to see if it’s worth it.
- Risk of not getting paid: There is always a risk that you won’t get paid for goods and services that you provide on credit. However, if you take the proper steps to check the customer’s credit history, require an upfront deposit, and stay on top of your unpaid invoices, you can minimize this risk.
- Time investment to stay on top of unpaid invoices: Unlike cash sales, you will have to be organized when it comes to managing your accounts receivable. Whether you, as a business owner, are responsible for this or your bookkeeper, someone will need to keep unpaid invoices on their radar by asking for payment via email, by telephone and, if necessary, by sending a collection letter by mail.
Overall, there are pros and cons of extending credit to customers. Increased sales, gaining a competitive edge, and building strong customer relationships can be worth the wait of getting paid as well as running the risk of not getting paid. The key is to stay on top of unpaid invoices so they don’t become delinquent. If you have a cash flow shortage, you may want to consider using an invoice factoring company while you are waiting to receive customer payments.
Use Invoice Factoring Companies to Support Cash Flow While Awaiting Payment
Extending credit to customers can help your business grow in the long term, but cash flow gets a bit messy when there’s a time lag between purchase and payment. Invoice factoring is one way to plug the gaps in cash flow; it advances you capital now in exchange for assigning unpaid invoices to the factoring company.
You may have heard negative things about invoice factoring. Traditionally, invoice factors would contact a small business’ clients to verify invoices and act as a collection agency to late payers. Understandably, this discouraged a lot of small businesses from using invoice factoring companies. However, a new breed of invoice factors, exemplified by BlueVine and Fundbox, allow you to get invoice-based financing while retaining control over your client relationships.
How Invoice Factoring Works
Both BlueVine and Fundbox will help you free up the capital that’s currently tied up in your unpaid invoices. However, the way they work is pretty different, as are the types of businesses they are well suited for. In both cases, you can receive advance funding on your invoices while you wait for your clients to submit their payments. This frees up your cash flow and can help you avoid funding gaps.
The qualifications you must meet for financing with invoice factoring companies like BlueVine and Fundbox are:
BlueVine is a good option for cash-strapped businesses that are awaiting payment on invoices. You can receive an advance of 85% to 90% of your invoice value upfront. The remaining balance, minus fees, is sent to you once the customer pays the invoice. You can get credit lines of up to $5,000,000 from BlueVine, with funding in as quickly as one to three business days.
Example: Let’s say you have a $10,000 invoice due in 30 days. If you are a first-time customer, BlueVine will advance you $8,500 up front. When the invoice comes due, your customers will remit their payments to a bank account BlueVine sets up in your name. BlueVine will send the remaining balance of the invoice (less fees) directly to you. If the invoice is outstanding for four weeks, the fee will likely range from a low of $250 to around $500, on average. In our example, this means BlueVine would send you $1,000 to $1,250 of the payment and keep the rest to cover the fee.
The nice thing about BlueVine is that there are no monthly payments to worry about once you’re approved for financing. You get a large advance upfront, which you can use to pay for operating expenses, working capital, or whatever else you might need it for. In addition, the funding you receive acts as a credit line. As your customers pay invoices, you get access to that money again to factor new invoices.
Even though your customers pay BlueVine directly through a bank account established in your name, they won’t know you are factoring their invoices. BlueVine assigns an account number and payment address using your business name, so your customers can still make checks payable to you. BlueVine will never contact your clients, which is a big advantage over traditional invoice factoring.
You choose the specific invoices to factor, but individual invoices must be at least $500. Plus, there are no contracts as there sometimes are with traditional invoice factors. BlueVine’s standard fee starts at 0.25% per week. So whether your customer pays their invoice in 10 days or 29 days, the fee is the same. Repeat clients, clients from certain industries such as trucking, and larger credit lines tend to qualify for lower fees.
Fundbox is another good option for businesses with unpaid invoices. Businesses can get up to $100,000 in financing based on the value of their invoices. Financing from Fundbox is structured like a line of credit with weekly payments.
Example: Let’s say you have a $10,000 invoice that will be due in 90 days. Fundbox will lend you the full $10,000. Then, you have to pay back the $10,000 plus the fees charged by Fundbox over the next 12 or 24 weeks.
With Fundbox, the fees start at 0.5% to 0.7% per week for a $10,000 invoice, which would be approximately $50 to $70 per week if you took 12 weeks to pay it back. If you took only six weeks to pay it back, then your fee would be cut in half, $25 to $35 per week. This makes Fundbox an economical option for invoices due in a short period of time.
As with BlueVine, Fundbox will never contact your customers. You receive 100% financing upfront and you pay back the loan week over week. If you can’t afford to make the weekly loan payments, then BlueVine may be better suited for your business.
Fundbox loans also work like a line of credit. As you repay what you borrow, the money becomes available to you again to factor additional invoices. The cost starts at approximately $50 to $70 in total fees for a $1,000 invoice over 12 weeks. As mentioned above, you can save on fees by paying the loan off sooner.
Funding is available from Fundbox in one to two business days, but in order to qualify, you must use compatible invoicing software like FreshBooks, Clio, Wave, Harvest, QuickBooks, or Xero. The application process is simple and takes only minutes to complete.
Frequently Asked Questions (FAQs) About Extending Credit to Customers
In this section, you will find answers to the most frequently asked questions about extending credit to customers. If you don’t see your question, head over to the Fit Small Business forum and post your question there. One of our industry experts will respond to your question.
The most frequently asked questions about extending credit to customers are:
Why do companies extend credit to customers?
Companies extend credit to customers because they want to give their customers the flexibility to purchase what they need without being limited by the amount of cash they have on hand. Plus, customers tend to purchase more when they can delay payment than if they have to pay for their goods and services immediately.
What is the benefit to a small business of providing credit to customers?
There are several benefits to a small business when providing credit to customers. Sales will go up because customers tend to buy more when they don’t have to pay upfront. You will have a competitive edge over other suppliers that do not provide credit to their customers, and you will gain customer loyalty and trust.
How do you give credit to customers?
After deciding to extend credit to a customer, determine the amount of credit to give a customer, review your credit policy with each customer, and have them sign off prior to providing goods and services on credit. Invoice customers one to two days after providing the goods and services, and follow up often to ensure prompt payment.
For many small business sellers, extending credit to customers is essential to business growth. When developing a credit policy, set clear terms, track payment deadlines, and only extend credit to customers who you trust. If cash flow is a concern, consider using invoice factoring to support your cash flow when you extend terms to customers.