What are the risks of extending more credit?

In every business cash is an important factor; therefore managing cashflow properly is crucial. Making sales on credit terms is a normal and expected component of doing business in many sectors. However, situations may arise where customers want to place orders above the agreed levels of credit. This can occur for various reasons, so how should business owners respond?

A customer may specifically request to extend the terms of their credit agreement; this may be either the amount of time before sending payment, or how much credit they can accumulate. In either case, this is a potential sign that the customer is experiencing difficulties with their cashflow and it should put a business owner on alert that the customer has higher risk attached to them. Understanding the reasons for the request is crucial in assessing the risk.

Should you agree to extended credit terms?

Business owners who are debating whether to agree to extended credit terms need initially to evaluate the potential risks and rewards. The biggest risk is non-payment; the higher the amount owed, or the agreed length of term, the greater risk the business is exposed to. Of course, there are benefits that working with a key customer can bring. For example, if the business agrees to increase the agreed credit terms, the customer may increase the volume of orders, which as a result could boost turnover and help the business to grow.

What’s right for your business?

Before making a decision, owners should consider what’s right for their business. Analysing financial information, including cashflow forecasts and aged debtor and creditor ledgers, can assist in revealing whether the business can afford to negotiate the provision of increased credit. Looking at the average length of time the business takes to collect payments, versus how long it takes to pay creditors, can be a good indicator as to whether the business is achieving the right balance in terms of risk and reward. If the business is making payments faster than it is receiving them, then it runs the risk of cashflow turning negative. Business owners would be well advised to consider how this might be perceived externally. For example, banks and other investors may be more inclined to partner with a business that has good control of its cash.

In summary, positives and negatives will always exist, and business owners should weigh up customer requests carefully before agreeing to any extended credit terms.

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