Why Customer Credit Reports Are Your Business

To protect your company's cash flow in tough times, you need a heads up on customers' ability to pay
Illustration by Pep Monserrat

Entrepreneurs, by nature, are a wildly confident lot. When you dream of things that don't yet exist, then leave a good job, raid your savings, and sacrifice family time to make it happen—well, confidence is a prerequisite. But an overly optimistic attitude can impair your judgment when it comes to your company's financial health. Right now, it's time to wave the yellow flag of caution.

We're coming off the economic equivalent of a fraternity kegger. Credit was cheap. Customers were easy. Money floated around, and the cost of being wrong was low. But now the campus police have arrived, and the hangover is kicking in. Unemployment is projected to rise as the economy contracts further. The worst is yet to come. When it does, will your business be ready?

The first step toward finding out is to build a financial forecast. You may have drawn up a pro forma cash-flow statement before, perhaps for a bank or an investor. It's a powerful tool that shouldn't be reserved for outsiders. With it, you can create a financial snapshot of your business, pinpoint tight periods and isolate factors that affect your liquidity. No doubt, one of your biggest vulnerabilities in this climate will be your customers' ability to pay.

If you don't have a pro forma cash-flow statement, start by focusing on how much you think you'll sell and at what price. Factor in financing activity, such as draws and repayments, and outline fixed expenses, especially those that can be slashed. When you're finished you'll have a monthly estimate of your cash-flow position.

Sobering? Let's hope not—at least not yet. Now it's time to figure out what happens if your customers pay late or not in full. How will that affect your projection? How much additional cash will you need to get by? If the picture isn't pretty, do something about it.

Start by looking at your customers' credit. It's a good practice to pull credit reports on them at least once a year. One source is Dun & Bradstreet; more specialized agencies may charge less.

Next, consider a chat with your competition, CFO to CFO. After all, who knows best if that new customer who's playing hardball will really pay? The customer making life miserable for the entrepreneur down the street is unlikely to treat you any better. Clearly, it's mutually beneficial to share such information. So ask about current terms, any amounts past due, and any refused deliveries. Check out your customers' Web sites to identify their business relationships. Watch the biggest companies closely, since they are more likely to push back payment on the small guys.

Don't be afraid to change the payment terms you offer based on this new information. A customer who had previously enjoyed a 60-day grace period may now deserve only 30; customers with 30 may be asked to pay COD.

It's also smart to collect credit-card numbers and bill to them automatically if the checks don't show up. That effectively shifts the burden of debt collection from you to the credit-card company—and yes, you're going to pay merchant fees of up to about 3.5% for that privilege. But it may be worth it for the peace of mind.

For more on how to build a pro forma cash-flow statement, check out Mehta's worksheet and sample.

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