- 25 Nov
How To Credit Check A Customer
Granting credit to customers is often a leap of faith so conducting credit checks on a customer can give some element of comfort to the supplier. However, even the most well known, household names can fail.
Recent experience with long established brands such as Thomas Cook, Mothercare and Debenhams (to name but a few that failed in 2019), shows that no one is immune to problems that can lead to insolvency. An understanding of how to credit check customers may help you improve the likelihood of getting paid by your customers.
This information is for information only, we can offer no guarantees that you will not suffer bad debts even after conducting this type of credit analysis. If you need protection against bad debts please read the information at the end of this article.
Customers that take trade credit from a supplier become debtors of that supplier. They are given a period of time to pay their invoices (most commonly 30 days in the UK), rather than having to pay cash in advance, or on pro-forma (both of which require payment in advance of supply). Typically suppliers will set credit limits for customers. This will be the maximum value of unpaid invoices that they can have outstanding at any time.
There is no way to be 100% safe when granting credit to customers, however there are some steps that you can take to credit check customers and reduce the chances of non payment. These are a few ideas.
For limited companies and some other business entities there may be credit reports available. Credit bureaus, such as Experian, Equifax and Dun & Bradstreet sell credit reports about businesses, that you can purchase. A credit report will draw together financial information, with other sources such as payment performance information, and details of any court judgements against them, in order to present a view of the credit status of a business. A credit limit may be also be suggested. This is of course no guarantee that you will be paid.
Some of this financial information is available for free. Companies have an obligation to file their annual financial accounts with Companies House, and using the Government's free service - you can search for the financial information on UK companies (also PLC's and LLPs). See my article about analysing financial accounts for a link to that site and some pointers on how to interpret financial accounts.
The same Companies House site also holds a list of all the company directors that have been disqualified. This occurs if a director fails to fulfil their legal duties regarding the running of a company, they can be banned from holding office as a director or company secretary for a period of time.
Also, by searching for particular directors on that site, you should see a list of all the other companies that they are involved with. This may allow you to identify previous insolvencies with which they were associated. You should look at any companies associated by directorship, in order to gain a fuller understanding of the position of any group of companies. For example, intercompany loans could appear as an asset within the company you are dealing with, whilst being due from an associated company that may not be in a position to repay the loan.
Bank And Trade References
It is possible to request reference from a customer's bank or suppliers. These are less frequently sought these days but can still be useful. It is worth requesting a number of trade references as it is more likely to reflect the customers true performance. Most companies will have at least one customer that they pay on time, to provide as a trade referee.
I always like to conduct my own, online research regarding customers. You can do this by using a search engine, such as Google, and searching for the company name, trading style and names of the prime movers. This may return any news stories regarding the customer, for example if they have been prosecuted for something.
Granting A Credit Limit
There is no sure way of ensuring that you don't grant too much credit to a customer. Try to ensure that the limit appears reasonable when compared with the volume of trade that they are transacting, If there are no turnover figures shown, this may be hard to estimate, but looking at the amount of outstanding debtors and cash within their balance sheet may give you some idea of the level of trade you would expect them to be transacting.
Ensuring that you have good credit control procedures in place will maximise your chances of being paid in a timely manner.
Bad Debt Protection
If you are worried about taking a bad debt, you could consider protecting yourself against that risk. The simplest protection is to trade only on cash terms (also called pro-forma) whereby you ask customers to pay upfront. Alternatively you could ask for a deposit that covers at least the cost of materials. However, there is often pressure to provide credit terms, in order to remain competitive with other suppliers.
A credit insurance policy can provide that type of protection for a premium, or if you use invoice finance, there are normally bad debt protection options that can be added onto your facility - to protect you against customers becoming insolvent and failing to pay their outstanding credit terms invoices.