It's 2022. How Much Credit Should I Extend to My Customer? - Webinar

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Reason to Extend Credit

First, we will look into some of the reasons to extend credit.

a. Customer loyalty

People like to be able to buy things on credit so that they do not have to come up with cash immediately. They will have some time to fund the purchase.

b. Financial position of customer (and you)

Your customer and you both have different financial positions. So if you have the ability to extend credit, that is a reason to extend credit. The customer has the ability to receive the credit because they are credit worthy, that is another reason to extend credit.

c. Industry standard

There are certain components of the construction industry where it is assumed that you will extend credit. So to not extend credit in those components and sections of the industry, you will be an outlier and it may be hard to get business.

d. Gain a competitive edge

It may also be difficult to gain a competitive advantage.

e. Increased sales

The more you extend credit to people, more likely than not, they will use more credit when they have the opportunity. As a result, you will likely increase your sales. But again, you have to be careful, because the more credit you extend, the more you put yourself at risk for someone’s inability to pay back on the credit that you have extended.

Ways to Check Credit

These are the ways to check your customer’s credit.

a. Have a credit application

You absolutely need to have a credit application, and these are the two reasons why this is important:

Get the information you need to review credit

You need to get the information you need in order to make a credit decision and review their credit.

Under the law you need written permission to review credit

Under the law, you need to get their written permission to review their credit and pull their credit. If someone comes into your office and says they would like credit, then you decide to run their credit. Legally, you need their permission, and you need their permission in writing to be absolutely secure.

So having a credit application that both gets the information about their business and has a provision in it that says they give you permission to pull their credit.

So what should be on the credit application?  

i. Business name

The business name is required. You would be surprised how often credit applications are seen where it just says something like ‘Smith Plumbing.’ it will not say Inc., Or LLC, or Corp. So you want to get their exact corporate name. That means it is going to have Inc., LLC, or Corp. You need to verify that information on the Secretary of State website for Florida.

ii. Address

You want to ask for their address.

iii. Tax ID

You also want to ask for their tax ID number.

iv. License number

You want to ask if they have a license. Whether they are a plumber, electrician, or roofer, you want to get this number.

v. Bank and business credit references

You want to get bank and business credit references. You need at least three or four, so that you can make credit inquiries to those sources. Everyone will cooperate with you which is why you need several.  

Other individuals in the industry may have a standard response which is to say that they extend credit. They will not necessarily give any details. But if you have several that you can ask, that will increase the likelihood of getting meaningful information from those credit references.

vi. Actually verify information

This is shocking as there are people who have obtained all of this information on a credit application but yet have verified none of it. Once you obtain the information, you need to verify that information. So if they give you their business name, you need to go on a site like sunbiz.org and verify that the company was formed when they said.

You also need to verify the offices that they said, the right address, tax ID number, if they say they are licensed, their license information from the Florida DBPR to verify that in fact the license is in their name, and not the license number of their cousin who happens to pull all the permits for them.

There are individuals that on a routine basis, obtain credit information, verify credit information, and determine that that information is inaccurate. That is a great way to get rid of the least credit-worthy people off the table. This is for people who are not telling you the truth on their credit application and people that you should not be extending credit to.

Ways to check Credit

You need to get someone’s written authorization to pull their credit information.

a. Get written authorization to pull background/credit information

On a credit application you are going to get their permission to pull their credit and use the information from their credit report and other information in their credit history to make a credit decision. Many times, people use the credit application to have the prospective customer sign their terms and conditions.

That is the best time to do it – when they need the credit, you have them sign the terms and conditions of sale that becomes the credit agreement. So it is not just the credit application, it is the credit application. You need the authorization to pull credit and all the terms and conditions of your sales.

You could have them sign that document later, but again, if you have them in front of you now, now is typically the best time to get them to sign all of your terms and conditions.

i. Dun & Bradstreet

There are some services that will pull credit for you. Dun & Bradstreet is probably the most common, so their website is dnd.com. You can set up an account. You can run people’s credit that wat. They have lots of other services to try to make the credit review process easier.

Determining the amount of credit and the creditworthiness of someone is as much art as it is science. So there is no hard and fast rule. There are people who will extend a lot more credit to people than they probably should, and everything goes well. They give a lot less credit to other people that seem credit-worthy, and things do not go well.

So there is no formula that anyone can tell you that will give you great certainty in the amount of credit that you give.  

ii. TLO (now part of TransUnion)

TLO, which is part of TransUnion, is another service that will help you pull credit-related information.

iii. Cortera

Cortera is a part of Moody’s, and they have a credit service as well. Those are great ways to pull, and you will pay a fee. Sometimes it is many tens of dollars. Sometimes it is several hundred dollars to pull someone’s credit.

b. Secretary of State

The Secretary of State again is a place where you want to pull information to verify the things that people say about their company.  

c. Public records

There are other public records that you should pull, that may be in Dun & Bradstreet or TLO. But not always. Because those services typically run a little behind and they are not 100% accurate.

So one of the things that are recommended when they are checking credit is to search in a few other places that are relatively easy to check.

i. Google ‘___ county recorded documents’

You want to Google whatever the county is. So if you are searching in Martin County for example, maybe that is where your customer is based. You will type in ‘Martin County’ recorded documents.

ii. Look for liens, releases, judgments, property transfers...

That is going to pull up lien releases, recorded judgements, property transfers, or anything that gets recorded in the public record. For example, you are about to extend credit to a customer, and you type in ‘Martin County recorded documents,’ and you find that they just had a judgement entered against them, maybe it is so new that it is not even in Dun & Bradstreet yet.

Maybe they recorded a lien against a piece of property for a lot of money, and that indicates they are owed a lot of money which may affect their cash flow. That lien is not going to show up in the Dun & Bradstreet or TLO report.

But it will show up if you search in the public records for the county where your customer is doing work, or prospective customer.

iii. Google ‘___ County Property Appraiser’

To see if someone owns any property, you want to do the same search for the name of the county followed by county property appraiser, so you should search ‘_County Property Appraiser.’ that is going to pull up current property ownership.

So if your company is ABC Plumbing, you are in your warehouse, and someone wants to see if you own your warehouse, you type in ‘Miami-Dade County Appraiser.’ That would take you to the Miami-Dade County Property Appraiser website. You would type in ABC Plumbing, and it will tell you any property that is owned by you.  

Remember that when you are doing these searches, if you are getting a personal guaranty from your customer that you want to run these searches not only for the company, but for all of the guarantors.

iv. Google ‘___ County Court Records’

Similarly, you want to search for ‘___ County Court Records,’ with the name of the county followed by the words ‘County Court Records.’

v. Look for open or closed civil and criminal cases

Finally, you want to look to see if there are any open pending civil criminal cases or what the old civil and criminal cases may look like. To do that, you need to type in the name of the county as mentioned above, followed by ‘County Court Records.’

So if you want to see what cases involved ABC Plumbing in Miami-Dade County, you would type in ‘Miami-Dade County Court Records.’ That will take you to the Clerk of Court website and you can type in ‘ABC Plumbing.’ It will then give you all of the cases that name you as a party, whether you are a plaintiff or a defendant.

You can actually look at all the case filings. Everything that has been filed in that case, you can find online.  

Now, all of the information described above is not going to be readily available in a Dun & Bradstreet or a TLO report. So that is why it is critical that you take these extra steps to check for credit.

d. Good old Google

Other things you should do is just type their name into Google. Ideally, their name is not so unique that you find lots of potentially unrelated but similarly named companies. Hopefully the name is unique enough so that you can find their name, especially if it is a unique person’s name.

i. Online reviews

You can look for online reviews. What are their customers saying? Are there complaints against their license? Do the people in charge have any mugshots online? Have they been arrested? Are there any bankruptcies? Are there any related companies? What does their website say? What do other websites say about them?

All of this is intended to give you a larger picture of the potential customer that you are going to extend credit to, to make sure that you are making the proper credit decision.  

How Much Credit to Extend

Now you have lots of information and you are not sure what to do with it. How do you determine whether you are going to extend $1,000, $5,000, or $100,000 worth of credit to this customer?

a. Not an exact science

As mentioned above, it is far from an exact science.  

b. How much are you willing to put at risk?

One of the things you need to determine is how much you are willing to put at risk with any given customer.

c. Is the debt secured?

You also need to determine whether the debt is going to be secured.

i. UCC

Are you going to have a UCC? That is not very common. You can get a UCC which secures your right to companies, potentially the receivables, or their inventory that they may have in a warehouse.

ii. Lien/Bond claims

Lien or bond claims are much more common. If you are going to extend credit to someone, are you going to do it on job accounts that are going to give you specific lien and bond rights, which is different than the house account or the shop account? This could be where they will come in and they buy 1,000 feet of copper wire but they are going to use it in different projects.

You will not have lien rights because you are not selling it for one specific job. One of the ways to potentially extend more credit and limit your credit risk is to use job accounts so that when they come in, they say that it is for the smith job, you notice, and you can use SunRay to send your Notice to Owner, your bond claims, and lien claims to secure your rights.

iii. Personal guaranty

Are you going to get a personal guaranty? Let us say you own ABC Plumbing, you are married, and your wife is unrelated to the business, but a customer has you sign a credit application and makes you sign a personal guaranty. You have a bank account with your wife and that bank account is titled in what is called ‘Tenants by the Entirety’ or TBE.

If the customer gets a judgment against the company and against you individually, they will not be able to get the bank account that is held with your wife as Tenants by the Entirety. Homestead is also typically untouchable.

Retirement accounts are also untouchable.

Maybe you have a piece of investment property with your wife. Maybe your customer will be able to attach their share of the interest in that piece of property. Maybe you do not even own it yourselves, maybe you own it in the name of a trust.

So these are all ways that people can shield their personal assets. Your customer may think that they have a personal guaranty so you should be able to get everything associated with them personally. That is not the case in Florida. Florida is a very debtor-friendly state.

If you are a debtor and you owe people money, Florida is the place to be. It is better to have a personal guaranty than not have a personal guaranty. But do not believe that the personal guaranty is the end-all-be-all at securing your rights.

Having lien and bond rights is probably more important than a personal guaranty, but getting a personal guaranty is great.

iv. Joint check agreements

Joint check agreements are another way to secure your right. So typically, that is not something you will get at the outset of a credit agreement, but maybe during a job. You may decide that you need to secure your rights because maybe the customer is paying late.

So you are going to get a joint check agreement. That is an agreement between you, your customer, and the owner, or the general contractor. This will say that when they pay your customer, they are going to pay you directly so that you get the money straight from the people that are paying your customer. You do not run the risk that, as it goes through your customer’s hands, maybe they use the money for something else.

d. Consider starting slow (like a credit card)

Start slow just like a credit card or a bank loan. This is very important. Do not extend significant amounts of credit right away. Get a track record of working with the customer, getting them to pay your bills, start developing a credit relationship, and then extend the amount of credit slowly over time.

How to Spot Problems

Some things to be on the lookout for before problems arise are as follows.

a. Pattern of late payments

Not every once in a while, but a pattern of late payments is an indication that maybe you need to reconsider the amount of credit you are extending.  

b. Different buying schedule

Different buying schedules going up and down are going to affect the amount of credit that you extend.

c. Selling of assets

If the other side sells a lot of their assets, it is a problem.

d. Changes in personnel

A significant change in personnel is another sign.

e. Closing locations

Closing locations are a bad sign.

f. Request for additional credit

Unusual requests for additional credit should be paid attention to. Maybe they are requesting additional credit because they have a series of new projects. But again, do not be so enamored with the potential sales, you need to make sure that you are protecting your business by not extending too much credit.

How to Prevent Problems After You Extend Credit

Some things you can do to prevent credit problems are listed below.

a. Re-run credit at least annually

Re-run credit at least once a year. Someone if people get the credit, they get the credit application, they run the credit when they open the account, and then they never do anything again. Well people’s lives change, and companies change. So having a process in place to re-run the credit and take another look at the business every year, or every 18 months, is a good idea. You could even decide to do it every two years.

But do not just run the credit and then never think about it again. That is a mistake because if things change, that will appear in a credit report or in some of the searches if you are not checking for it, you will not be the last to know.

b. Check on job/equipment status

Checking on the job, and if you rent equipment, for example, checking on the equipment. You want to make sure that the sales you think are going to a job or actually going to that job. For example, if you are a rental equipment company, do you have your salespeople going and verifying that the equipment is on the job that they say it is on so that you know your lien rights are good?

Make sure that you identify where your equipment is going. Because if you deliver to a jobsite, your customer picks up the products and moves it to another job site without you knowing, and you lien the first job for all of the unpaid amount, they can say they do not know why you are liening their jobs. Because the product is not there, it was there for just a week, but you have a lien for a month.

Because your customer picked it up, put it in the truck and took it somewhere else. So be aware of that.

c. Meet with clients and listen carefully

Meeting with clients and listening carefully is a great way to keep an eye on what is happening in your business.  

d. Communicate with your sales team

Communicate with your sakes team because your sales team is going to be the one dealing with the customer. What are they hearing about the customer about their business, any changes in their business?

e. Keep good records

Keep great records of all of the things listed above that are very important. So if there is a problem, you are able to support your claim in a court case.

Pro-Tip: Do Not List the Credit Limit on the Credit Application

Now we have a pro-tip. Do not write the credit limit that you are extending to the customer on the credit application. If someone comes into your shop and fills out a credit application, you may request a certain amount of credit you may say on the credit application. How much credit do you want? You could write in $10,000 a month.

What you do not want to do is review all the information mentioned above and then have a spot on the credit application where you mention how much credit you are agreeing to extend. The reason why you do not want to write that on the credit application is because that will be considered the amount of credit that you determine should be given. And to the extent you extend more credit than that and the credit decision does not turn out well, meaning the customer fails to pay you.

‘They’ the customer, in a court case can use the determination that you are only going to extend the amount of credit as a basis for refusing to pay anything more.

For example, if someone comes into your shop and says they want $5,000 a month, you will agree to give them $5,000 a month. You both develop the relationship slowly over time and you write $5,000 credit extended on the credit application.

Over time, you decide maybe $7,000, $10,000, or $20,000 a month. Then something goes wrong and for three months, you are not paid $20,000 a month. That is a total of $60,000 that you were not paid. So you sue them. One of the defenses you can use in that case is that you should not have extended to you all that credit. You said you were only going to extend the individual $5,000 of credit a month.

So, you extended an additional $15,000 a month. You should be responsible for all that overage. It should not be the other side’s responsibility. That may sound crazy, but it is actually a valid defense in the state of Florida. It does not always work but it is something that the defendant can use.

So do not write on your credit application how much credit you are going to extend. Write it somewhere else in your software system that you use to manage your accounting. Put it someplace else, but do not write it on the credit application so that it is obvious to the other side in a court case how much credit you agree to extend.