Using the Credit Application as a Tool

Establishing trade credit is the lifeblood of many small businesses. The effective use of trade credit can be a financial tool that helps your customers grow and, in turn, helps your business grow. However, too much of the wrong trade credit creates risk.

The credit application is the first step taken when a customer requests trade credit. The trade credit application serves as a sales tool that can help maximize your growth while minimizing your risk.

Trade credit starts to build a business relationship on trust. This can lead to additional sales and less price sensitivity, while creating a partnership approach to business.

Remember, a tangible asset usually does not secure trade credit. A credit application may seem simple, but in fact the details are complicated and likely to cause problems in the event of a default. Here are some details not to be overlooked when assessing your customer’s application for trade credit.

Get Complete Information

Many small business owners skip the details when filling out an application for trade credit. These small details skipped in the beginning of a trade credit relationship can create big obstacles when trying to collect an overdue account. You can assume that almost every business will face a downturn. You simply want to be prepared.

Don’t go the route of using a generic credit application form. Your business is unique; gather the information that is particular to your industry, and include it with standard information found on most credit applications.

As an example, for the construction trades, ask for average project size, number of projects per year, number of employees, and company ownership. Gather the personal addresses, phone numbers, cell phone numbers and email addresses of each of the owners. This information may become important in the event of a delinquency.

Insist on the last two years of financial statements. You may get some pushback on this request, but it is a perfectly reasonable considering you are helping finance this business.

Verify Everything

Most companies will verify address, trade reference, credit reports, bank and credit card information. What is often overlooked is the business entity registration with the Secretary of State in the firm’s home state. This information is usually readily available online. The business entity registration can provide detailed insight into the company and verify the accuracy of the information provided on the trade credit application.

Understanding the corporate structure of an organization for the first time during the collection process is an uncomfortable position to be in.

Personal Guarantees

Trade credit is unsecured. Many small business owners balk at signing a personal guarantee, but it may be the only form of security you have. Although a personal guarantee is not secured by a specific asset, in the event of non-payment, your business can attach the guarantor’s personal property. Additionally, a personal guarantee is an assurance that the owner is committed to the business (and repayment of your loan).

An important note about personal guarantees: Make certain there is either a separate signature line expressly for the personal guarantee or a completely separate document prepared by your attorney.

Arbitration Clause

Here is a sample arbitration clause, “All claims and disputes arising under or relating to this Agreement are to be settled by binding arbitration in the state of [insert state in which parties agree to arbitrate] or another location mutually agreeable to the parties. An award of arbitration may be confirmed in a court of competent jurisdiction.”

Don’t Rush the Process

Beware of the end-of-the-month big rush order! It always seems to happen. The sales manager has a large order he needs to enter to make an end-of-the-month quota. So they want credit approval fast.

Last-minute pressure increases the risk you may take by not fully reviewing and researching the credit application. Take a solid look at any credit application and, if it needs to happen quickly, it may be an indication that the credit application is suspect.

Trade credit has helped many companies increase their purchasing power, develop new relationships and grow their business. But it does carry some risk. A thoughtfully developed credit application, with enough information to evaluate your client’s credit worthiness, will strengthen your credit risk management system.

The information contained in this article is for general guidance only. It is recommended you contact an attorney to review any documents prior to implementation.