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Home>Business Resource Center >Financial Articles >Taxes and Accounting

Credit Checks

It's exciting to get a new customer – but not if they fail to pay their bills on time… or at all. If you run a cash business, credit checks aren't an issue. If you will extend credit by invoicing after goods or services are provided, the only way to determine the likelihood of a new customer paying on time is to perform a credit check. Before you extend any form of credit to a new customer, take these steps to check the customer's credit history so you can decide whether, how much, and under what terms, to extend credit.

The first step is to create and use a credit application form. Your form can be as simple as a one page form providing contact information, bank references, and trade references. Your goal is to get sufficient information about the customer so you can make an informed decision about whether to extend credit.

Here's what you'll do:

• Get written permission from the customer to allow its banks and vendors to release payment and balance information to you.
• Get names and contact information for at least three vendors. Try to get contact information for vendors who have long-term business relationships with your potential customer.
• Get contact information for banks with which the customer currently has accounts. Ask for contact information for specific individuals at those banks so you can be sure to talk to someone familiar with the customer. If you like, take it a step further and ask for previous banks; talking to those contacts may give you an even better sense of the customer's credit worthiness.
• Call the customer's vendors. Ask for accounts receivable, and ask them to verify the customer's payment history. If the vendor requires written authorization to release information, send a copy of the authorization you had the customer sign. Pay special attention to any comments about late payments.
• Call the banks. Ask for verification of the length of the business relationship and for details about the customer's balance history. If a bank requires written authorization to release information, send a copy of the authorization you had the customer sign. Pay special attention to any comments about dramatic fluctuations in account balances.
• Get a business credit report. While the information isn't always accurate – just like with personal credit reports – a business credit report can help confirm information the customer has provided.

Keep in mind that none of the above guarantees the customer will pay on time. If you want to err on the side of caution, process small orders first and see how quickly the customer pays before accepting larger, riskier orders.

Make sure you decide how much risk you are willing to accept, and establish appropriate terms. You may require payment upon receipt of goods or services, at least at first, until you feel comfortable with the credit-worthiness of the customer. Or you may require payment in five days; later you could relax those terms.

Feel free to let the customer know – politely – that you want to ease into the business relationship, at least where extending credit is concerned; most will work hard to earn your trust by paying on time. If they don't, you probably can't afford for them to be your customers in the first place.

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