Considerations involved in deciding whether to extend credit

The most basic consideration in extending credit is obtaining reasonable assurance that you will in fact get paid. This primarily means knowing who you are dealing with. Credit should not be granted without first having sufficient knowledge of the potential customer and their ability to pay.

The decision as to whether to extend credit to a potential customer of your small business will probably be a function of the amount involved in the potential sale and the probability of continued, ongoing business with that same customer. If the amount of the sale is significant, in terms of your small business, you should do an evaluation before extending credit, even if it is a one-time sale. And if this is a customer with whom you hope to continue doing business in the future, it will be important to first assure yourself of the credit-worthiness of the potential customer, and then to establish clear credit guidelines that are acceptable to both parties. This will enhance your business relationship with that customer, as well as your own reputation as a solid business, for other potential customers in the future.

The decision to grant credit terms obviously has a direct effect on your small business’s cash flow, so it is a decision that merits the necessary consideration. When you are just starting up and are short on cash, it may be more difficult for you to grant credit terms. But at the same time, you won’t want to lose a valuable customer just because they normally work with payment terms of 30 days. So you will need to weigh these factors in your decision. In many cases, credit terms can be negotiated. A basic rule would be not to extend credit to the point where it jeopardizes the solvency of your small business.

There are different spheres in which to evaluate the credit-worthiness of the potential customer. These include an evaluation of the financial situation of the potential customer, the conditions in the market segment in which it operates and general economic conditions, and data related to the company itself and its management.