It’s an unfortunate fact that some customers are not trustworthy and even many honest customers don’t pay on time. Industry research indicates that more invoices are paid late than not. Implementing an effective credit policy that includes checking the credit report of new customers can help you avoid the customers who are most likely to not pay their debts.

Why You Need To Check Your Customer’s Credit Report

Business-to-business customers expect to be able to purchase goods on credit, but delivering goods to a customer before you get paid is inherently risky. B2B trade credit is unsecured debt that is largely unregulated. This makes it easy for customers to not pay for purchases without fear of significant repercussions. 

Even customers who fully intend to pay you on time could run into financial difficulties. When companies are struggling, unsecured debt is usually the first bill they don’t pay. When customers pay late or not at all it can create cash flow problems that could negatively impact your business.

There are steps you can take to deal with customers that don’t pay, but this takes time and costs you money. It is better to avoid selling to customers who are at a high risk of not paying. This is why it is important to effectively assess how likely your customers are to pay before you allow them to purchase on credit. 

What Makes a Customer Creditworthy

The basic components of creditworthiness are a customer’s reputation for paying on time and the ability to continue to pay on time. There are five factors to consider when determining how creditworthy a customer is.

1. Character

Character describes how trustworthy a potential customer is. It measures how likely the customer is to intend to pay their debts. You can check the character of a potential customer by asking for business references, reviewing the business’s credit report and researching the reputation the business has in the industry.

2. Capacity

Capacity measures how likely the potential customer is to be able to pay their debt. To assess capacity, review the business’s cash flow statements, check its debt-to-income ratio and review its past revenue statements.

3. Collateral

Sometimes businesses that lack the cash flow to pay debts sell other assets to cover the deficit. A business that has assets, such as accounts receivable or equipment, that could be liquidated to cover unpaid debts is more likely to be creditworthy.

4. Capital

How well capitalized a business is can also indicate the business’s ability to pay debts. Reviewing the potential client’s certified financial statement can help you assess this.

5. Conditions

Examine conditions that could cause your potential customer’s business to have financial trouble. Examples include economic conditions, industry trends and political instability in the country it operates in.

How To Assess a New Customer’s Creditworthiness

One of the most effective ways to avoid extending credit to customers who pay late or do not pay at all is to implement a system to check every new customer’s creditworthiness before you extend them credit. There are six techniques you can use to assess your customer’s credit.

1. Check the Customer’s Credit Report

A business credit report contains a record of its payment history. It also includes financial data, such as annual sales, credit limits, invoice activity, collections activities and legal judgments. In addition to the report, the business’s credit score is an indication of its financial stability and ability to pay its debts. 

Business credit scores range from 1 to 100. A score of 75 or higher is excellent. The major business credit reporting agencies include Dun & Bradstreet, Experian Business and Equifax Business. The PencilPay platform makes it possible for you to obtain a potential customer’s Equifax credit score and report with one click.

2. Compute the Business’s Debt-to-Income Ratio

A company’s debt-to-income ratio is a measurement of how much debt the company has compared to its income. Divide the company’s monthly debt payments by its monthly income to get this ratio. The lower the ratio is, the more likely the company is to be able to pay your invoices. 

3. Review the Company’s Financial Reports

Request and review the company’s certified financial report and cash flow statement. This should help you assess the company’s overall financial strength and any cash flow issues that could impact its ability to pay your invoices.

4. Request References

Asking for references can be a good way to supplement the payment history information on a credit report. Ask how long the business has worked with the client, what the client’s credit limit is, when the last time the business made a purchase was and how often the client has been late on a payment.

5. Assess Regional Trade Risk

Fluctuations in currency exchange rates, trade sanctions or embargos and political or economic instability can make extending credit to businesses in some regions riskier. Familiarizing yourself with regional trade risks is important before extending credit to businesses that operate in other countries.

6. Check the Customer’s Pencil Score

The Pencil Score is a predictive trade credit score that helps you assess a potential customer’s likelihood to pay on time by adding a layer of information beyond a standard credit score. The Pencil Score utilizes machine learning technology to analyze a business’s payment history.

The Pencil Score ranges between 1-1000 and is viewable on your dashboard of onboarded customers. You can also view how the client’s Pencil Score has changed over time to determine whether the client’s payment habits are improving or getting worse. Combining the Pencil Score with the other information you have about a client helps you make better decisions about extending credit.

How PencilPay Helps You Implement Effective Credit Policies

PencilPay’s easy-to-use digital platform incorporates all the tools you need to quickly check your customer’s credit report, assess a customer’s creditworthiness, manage your trade credit and collect payments. It eliminates the need for time-consuming paper credit applications and helps you make better decisions about which companies to do business with. When you use PencilPay, you can feel confident in your credit decisions and quickly onboard the customers who are the most likely to pay on time. Contact us online to find out more about how we can help you improve your B2B trade credit management.