Is it worth taking the risk that could either make you or break you? There are both advantages and disadvantages of selling to customers on credit and a business owner must think carefully before deciding whether it is worth taking the risk.
Advantages of Trade Credit
Competitive edge. Offering trade credit will give you a competitive edge over your business rivals. Customers would generally favour the chance of selling and obtaining payment from their customers before having to pay for the goods you have sold to them. You may also need to offer such an incentive just to stay competitive especially if your rivals are already doing the same. A way of being more competitive is to offer greater terms and a discount for early payment.
Increase in sales. An increase in sales may happen when you start selling on credit. Your customers are likely to buy from you as their cash flow is not disrupted and it is not necessary to pay upfront to competitors.
Better customer loyalty. Offering credit to customers demonstrates trust. The fact you trust them to pay bills by the due dates encourages a loyal business relationship. It is likely that a loyal customer will choose you over another business when bidding for goods or services.
Disadvantages of Trade Credit
Funding your debtor book. Offering credit terms to customers will directly affect your cash flow. You must calculate how much your debtor book will increase and then find a way to finance it. You could do this by obtaining credit from your bank (e.g. an overdraft, invoice discounting, etc) or increasing credit terms from your suppliers.
Taking a credit risk with customers. The creditworthiness of each customer must be analysed. This will require checking the customers' credit references and obtaining a business credit report. These are however a snapshot and do not paint the whole picture of a company’s financial position.
Potential for bad debts. Even with all your checks in place, you are still likely to come across a customer who can’t pay. When this happens, you could pass the account to a collection agency, but you will incur fees. If collection efforts don't work, you will need to write off the overdue account as a bad debt.
Offering credit to customers is a necessary evil to remain competitive in the marketplace. However, there is a way to combat the disadvantages of offering trade credit and that is trade credit insurance.
A Trade Credit Insurance Policy:
- Covers risk by paying claims against companies that cannot pay you.
- Provides all the information needed to decide whether your customer is creditworthy as the underwriter does that for you.
- Supports credit control as you must notify possible overdue accounts to start the claims process.
- Stands you in good stead with the banks as they are more willing to support your need for a line of credit.
- Encourages suppliers as they know a bad debt will not destabilise your business as you are protected.
CMR as your trade credit insurance provider would start recovery proceedings in the event of any struggles you may have. These costs incurred are recoverable from the insurer. CMR prides ourselves on our competitively priced and simple to administer policies. For more information on how our trade credit insurance policies work, please do not hesitate to get in touch.