Does the phrase “extra credit” give you horrifying flashbacks to high school? When you’d already done the essentials, but suddenly you were expected to do even more? You might have been told back then that it’s always a good idea to go the extra mile, and that philosophy continues to be great advice to this day (sorry).
The good news is going the extra mile when it comes to trade credit is about more than sucking up to your teacher or boosting your GPA. Asking the right questions and making sure you have a full, in-depth understanding of potential customers before you extend trade credit protects your business. It makes sure you only do business with stable, secure companies that aren’t going to leave you in the lurch with unexpected financial difficulties or late payments.
So how do you gain that level of understanding before you extend trade credit? Here’s what you should be asking.
1. How much debt does the company have?
The last thing you want to be for a business is the straw that breaks the camel’s back. If a company is already over-leveraged, there’s a much higher likelihood that they could delay your payments. If things get more difficult for a business and they need to start prioritizing which bills they pay each month, they’ll likely focus on their older or more long-term debt. That means you, as a more recent creditor, could be left in the lurch.
Don’t get me wrong, I’m not suggesting that you avoid businesses who have debt. If you did that, you probably wouldn’t have many options! Carrying debt is just a part of doing business for most companies. The key is to look into the sources of debt and how good the business is at paying it back. Are they carrying long-term loans for things like office space and warehousing? That’s pretty typical. But debt when it comes to legal fees, last-minute fixes and day-to-day operations could be a red flag.
Indicators like a company’s Days Beyond Terms (DBT) can provide some insight into the level of debt they’re currently carrying. This figure on a business credit report shouldn’t be ignored: it tells you how many days, on average, the company is late in paying their bills. If you notice a very high DBT, or one that’s fluctuating month over month, that business may be struggling with too much debt. They might not be the most reliable customer for you. Or, on the other hand, you can use DBT to set your own expectations when it comes to the customer relationship. If you see a business has a consistent DBT of 5, for example, you might consider waiting a week past when a bill is due before nudging.
2. What does revenue growth look like in the last 4 reporting quarters?
This one sounds like a no-brainer, but that doesn’t mean revenue growth is any less important. And when you know what you’re looking for, you can get a lot more than a yes or no answer when it comes to extending credit.
When you look at a business month over month, the best thing you can see is consistency. If a company reports massive financial gains in one quarter, but little growth in the next, think critically about why that might be. In some industries, seasonality could play a huge role in that. If you understand the industry, you’ll be able to predict when those surges in growth will come up. Plus, if you don’t see a surge when you expect, you can flag it.
In other industries, however, you’re likely looking for stable, consistent revenue growth quarter over quarter. It can be tempting to extend credit to a company that reported huge growth last quarter, but if you’re only looking at that last quarter you won’t have a clear enough image of the business. If revenue growth is unstable, you don’t know where they’ll be in the following quarter – y'know, the quarter they’ll likely have to pay you during?
3. How do they manage inventory?
I’m sorry to bring up the T word again – it probably feels like it’s all you’ve been hearing about over the last few months – but tariff uncertainty is a key issue when it comes to extending credit.
Our research study Tariff Risks in the Supply Chain found that many businesses are trying their best to think ahead when it comes to tariffs. And part of that involves buying more inventory to potentially save on import tariffs when the time comes. In fact, nearly half (48%) of surveyed businesses confirmed they’ve increased their inventory, with 11% of those businesses increasing their purchases by an additional 26-50%.
It can pay to be proactive, but inventory hoarding can also backfire. Think about the costs associated with carrying excess inventory. Suddenly, your potential customer is facing increased storage, insurance, tax and labor expenses. And if tariffs come into place that don’t align with their predictions, they could be stuck with excess inventory that they can’t sell. It’s a slippery slope to revenue and other financial problems from there – and your business could feel the impact.
4. What does customer acquisition, retention and account growth look like?
In a good customer relationship, their success is your success. After all, you’re relying on them to be able to pay you back in good time and, hopefully, spend more money with your business as they expand their own. That means it’s in your best interests to know how they’re doing in terms of customer retention.
Ask about how their customer growth and management looks like year over year. If the numbers are increasing, that’s a good sign, but things don’t end there. Are their contract values rising in parallel? Knowing that your customer has a solid (and expanding) customer base means you can be more assured that they’ll have the available cash flow not only to pay you back on time, but to potentially increase their orders with you year over year.
On the other hand, let’s say those numbers are flat. That could suggest one of two things. The first is that the business is stable, but not necessarily focused on growth. That isn’t strictly a bad thing, but you’ll need to keep in mind that if they start losing customers, they’ll be in a worse position faster than if they were paying attention to increasing their customer base year over year. The other possibility is that, while they’re continuously signing new customers, they regularly lose them at the end of their contracts. That could suggest that their customers aren’t happy with the product or service they’re receiving and the business has problems with retaining their customers. There’s probably a finite pool of potential customers – what happens when they’ve gone through them all?
5. What are their payment collection processes?
When we say that it’s important to look at a business as a whole, we mean it. Think about it: you want the businesses you work with to be in the best possible position to pay their invoices on time. But if you’re just running a quick credit check and looking at their business credit score and limit, you’re missing out. Asking about their own payment collection processes gives you a better understanding of their overall financial health. If they don’t have a solid payment collection process in place, they’re much more likely to have customers who pay them late – or not at all.
This is where DSO, or Days Sales Outstanding, comes into play. This number tells you how long it takes a business to receive payment from their customers. If the figure is high, it could suggest that their payment collection process isn’t working properly for them. In an ideal world, your customers would be just as risk-adverse as you are, which means they’d assess risk of their customers by payment behavior to help decrease their DSO. Our research study Perils of Rising Debt and DSO found that 57% of surveyed businesses reported their DSO had increased in the last 12 months, suggesting that customers are, overall, paying invoices later. But when you prepare for each new customer relationship by asking the right questions and doing in-depth research before signing the contract, you’re putting your business in a much better position.
No more surprises when it comes to customer creditworthiness.
Enjoy a free trial of Creditsafe's business credit reports.
About the Author
Yesinne Alvarez, Manager of Partnerships and Alliances, Creditsafe
Yesinne Alvarez is Manager of Partnerships and Alliances at Creditsafe and supports the Trade Data Team with deep cross-functional expertise. With extensive experience in Relationship Management, Project Management, and Business Development, Yesinne brings both authority and trust to her role. Her background includes senior roles in recruiting and strategic development for Fortune 100 companies.
Chapter 1