Credit and collections for small business

Types of Credit• The two general categories of credit: CONSUMER CREDIT TRADE CREDIT Consumer credit is extended from retail stores to the customer.. Reasons to Extend Consumer Credit

BUS 204 Credit & Collections Spring 2006 copyright, SJHCredit & Collections

For Small Business

What is Credit?

• It is “credit” that makes the

world go round, not money!

• Much of what is bought and

sold is not paid for in advance,

but after the delivery of goods

or services.

• In other words, the seller is

taking a chance Trusting that

the buyer will pay at a later

date.

CREDIT: a

system of doing business by

trusting that a

buyer will pay at

a later date.

Types of Credit

• The two general categories

of credit:

CONSUMER CREDIT TRADE CREDIT

Consumer credit is extended

from retail stores to the

customer.

Trade Credit is extended from

one business to another

(wholesaler to retailer).

Reasons to Extend Consumer Credit

 To attract new customers

 To increase sales

 To offer convenience &

customer service to clientele

and encourage them to come

Credit as a Pricing Strategy

 A major reason to extend credit is for a marketing,

or more specifically, a

pricing strategy.

 By offering installment or deferred payment plans the buyer is provided with

a more comfortable alternative for getting what they want

The RISKS of extending Credit

 The Owner could lose money if

the buyer does not pay the

amount promised.

 The Owner needs to pay the

cost of the goods or services

in advance

 This means the owner must

have sufficient working capital

or money on hand to finance

the time period.

The RISKs of NOT extending Credit

“Charge, charge, charge!”

Guiding Principles for Extending

Credit…Factors to Consider

• Your Industry- is it customary in your

industry to extend credit?

• Your

Customers-Are you dependent upon repeat customers?

Do you know and trust your customers?

Do your customers have big buying power?

• Your Location- is it economically suitable?

• Your Transactions- (number of

transactions and the size $$$ of

transactions)

• Your Financial Condition- extending credit

may be limited if your credit is not good

Extending Credit Options

Credit comes in many shapes & sizes

 Offer to accept checks (still

finance their purchases with

outside finance companies

We proudly accept Visa, MasterCard, Discover Card, American Express…

Installment & Open Charge

Accounts

• Installment Accounts allow a customer a

long time (often several years) to pay for ticket items The monthly payments include

big-repayment & interest This financing is

common at furniture & appliance stores and for vehicles.

• An Open Charge account allows a certain

length of time (30 days), interest is normally not charged This was common for “general stores” and is still utilized in smaller towns today.

Revolving Charge Accounts

• A Revolving Charge Account allows the customer a specific amount of credit

• Purchases can be made at anytime, as long as they

do not exceed the credit limit.

• Monthly payments are required and usually include

an interest charge.

• The difference between “Revolving Charge

Accounts” and Credit Cards are:

1) with a Visa the seller gets the “cash” quickly

from VISA (even if the buyer has not paid for all of it)

2) Revolving Charge Accounts are “in-house”

• At the completion of the project the

customer pays the remaining 33%.

•Progressive payments work well for many service companies.

•For larger projects (construction) there may

be more as many as 9 or 10 progressive

payments.

Accepting Credit Cards

In your Small Business

How Popular are Credit Cards?

• 70% of all US adults use credit cards to

make purchases

• Total Number of Credit Cards in

Circulation exceeds 1 billion!

• Average customer uses a credit card

5.5 times per week!

• Consumers use credit cards on $28 out

of every $100 on consumable goods

• Can You Afford Not to Accept Credit

Cards?

The Price of Accepting Credit Cards

The convenience of credit cards is not without cost!

• Typically business owners pay 2-6%

of total credit card charges

• Also, transaction fees of 5 - 25

cents

• Merchant cards are often on a

“multi-step” process depending on monthly sales amounts

• Additional costs for leasing or buying credit card equipment

• Be sure to factor all of these costs into your pricing!

How a Merchant Account Works

In a nutshell

1 Your customer, the Cardholder ,

obtains a VISA through an

Issuing Bank

2 You, the Credit Card Merchant ,

obtain a Merchant Account from

a Sponsoring Bank

3 The Sponsoring Bank is really

offering you “an unsecured line

of credit”, and yes, you must

apply and show solid

creditworthiness-Merchant Account Cycle part 2

4 You take the customer’s card, and process the sale

(possibly getting an authorization code from your Sponsoring Bank.

5 Your Sponsoring Bank typically uses a Processor

to acquire the credit card transactions from you

and processes them through the Issuing Bank and your Sponsoring Bank.

6 You get paid when the customer charges & when

you submit a deposit transaction credit card

receipt… this process is known as “settling”

7 It may take a few days for the transaction to

process, and for you to obtain the money in your account (minus the processing fee)

Merchant Card Responsibilities

• In submitting the deposit transaction, you are

promising the Issuing Bank that you will

deliver the goods to the Cardholder.

• These are the expectations or “trust” that

makes the cycle work.

• Sometimes there are glitches in the system

that you need to protect yourself from

1) The Cardholder doesn’t believe you delivered the

Ways to Minimize “Chargebacks”

and other Credit Card Risks

• Keep good records….

• Sponsoring Banks have guidelines

that suggest you also obtain the

Cardholder’s phone number.

• Verify the card number and the

cardholder’s signature on every

transaction.

• Question shipping to an address that

is different from the Cardholders.

• Know your Cardholder personally.

• Advise shopper’s of your credit card

policy and return-warranty policy.

Minimizing Charge Backs

• Do not submit the deposit transaction until you have “officially” delivered the goods.

• If you need to prove that you DID

honor the transaction, do it in a timely fashion.

• If you honor refunds, honor them promptly.

• Check frequently with your merchant

account banker to make sure your

credit stays healthy!

Credit Basic Documents

• A written Credit Policy

• Loan Application Form

• Request for Credit

Your Written Credit Policy

• Describes the terms and conditions

upon which you agree to grant

customers credit.

• Makes it CLEAR to the customer

exactly what will be involved before

going further with the transaction.

• Provides uniform guidelines to all

employees.

• Is a convenient checklist for owner to

remind themselves of the procedure.

• Should compare to terms offered by

competitors.

Sally’s Boutique Credit Policy

It is the policy of Sally’s Boutique to extend credit to customers

purchasing more than $100 worth of merchandise in a single

transaction, not to exceed $500

Such credit will be extended provided customer agrees to a

credit check and has a credit score of 680 or above

Payments may be agreed to be installments, but the

total term of the repayment shall not extend beyond one year

Customer must complete a loan application form, a request for credit information form, and must sign a loan agreement Interest

charged shall not exceed 12% per year

All credit extended to the customers and all transactions to be paid on credit are subject to the approval of the owner of Sally’s

Boutique

No item purchased on credit may be returned

All items purchased on credit shall require at least 10% down

payment

The owner reserves the right to not extend credit to any customer and reserves the right to make exceptions to this policy.

The Loan Application

• Standard Loan Applications are available in

Loan Application Continued

Is the applicant a business owner? (if so, name and address of business)

Is the applicant married? Is spouse

co-signing?

Customer “Personal Financial Statement” showing all obligations and all revenue

List of references

Questions on litigation or convictions

Finally, the application must be signed &

dated.

More documentation

• After the application the next step is to customer fill out Request for Credit Form

• A signed written Purchase Order or

Purchase agreement is also important (shows evidence of sale) It should

include price & date of transaction.

• Next, you and the customer should sign

a loan agreement, which specifies the

terms & agreements of the loan How

much to be re-paid in total, principal,

interest and number of installments.

Why all these forms?

Yes, we are extending credit

to get customers, but it “Could be

Risky” and we could lose money!

The Credit Policy puts the risk factor up-front and includes the customer

in the process.

As a business owner, you need

to consider the worst case scenario.

File and Keep all the Important

Documentation

• All the credit documentation and any further

communication should be safely filed.

• The file should over time include:

Copy of Credit Policy, the original Credit Application,

copy of Credit Information Request, the original

Purchase Agreement, the original Loan Agreement

and/ or Security Agreement.

Over time, any additional communication,

memoranda of conversations, copies of all invoices

and statements and a customer ledger.

This is an “accounts receivable” type of file

These documents should be held for 7 years after

the final transaction.

• Net 30- no discounts given

and full amount is due in 30

days of invoice (very

common in retail

• Other “cash” discount

incentives to consider

Trade Credit “Net” Terms

• 2/10 net 30

Gives customer 30 days to pay the invoice and

offers a 2% discount if paid in 10 days

• 2/10 net 30 E.O.M

E.O.M means end of month (that means the 30 days does not start until the end of the month)

Definitions - Invoice Trades & Cash

discounts are taken

• Trade Discount reductions from the

manufacturers list price