What is credit checking and why bother?

If you sell to other businesses, giving credit is probably something you do without even thinking about it. It's a normal part of doing business. Your customers expect it...

This doesn't mean however, that you should give it automatically. Selling on credit, without checking the customer's ability (and inclination) to pay is a high risk strategy, and relying on the courts to get your money if the customer's gone bust is an equally costly and high risk strategy.

Credit checks allow you to make informed decisions about which customers you extend credit to - and how much you let them have at any one time. The first stage is to ask new customers to complete a credit application form. This will give you basic information about the business and will give you enough information to approach a credit reference agency (see below).

The form should ask for the following information:

• Customer's full name and trading address
• Invoice address, if different
• The company's legal status - limited company, partnership or sole trader
• Company information such as trading activity and number of employees
• Credit required
• Name and address of two trade references
• Banking details
• Company registration number (if limited company)
• Name(s) of directors and formation date of company (if limited company)
• Name(s) and home address of owner or senior partner (if not limited company)
• Length of time the business has traded.

The next step depends on how much credit has been applied for. If it's not very much you might just accept the risk and not do any further checks. If it's a significant amount you could take one or more of the three following checks:

Trade references

Trade references should be treated with some caution. A customer is unlikely to give you the names of people who will give them a bad press. You should remember as well that companies don't have to respond to your request for a reference.

Draw up a questionnaire and make it as simple to complete as possible. You should ask how long they have known the customer, what credit terms they offer them, average sales per month to that customer and payment history - are they usually on time, 30 days late, 60 days late etc. You can also ask for any other useful information. Include an SAE and offer to reciprocate in kind if needed.

Bank references

Also called a status enquiry, bank references can only be given with the written permission of the account holder and most banks will charge you a fee for providing them. The reference will be given in the form of an opinion as to whether or not the customer can meet its financial commitments and is good for an additional £5000 per month (or the credit you plan on extending). Remember that a bank's main loyalty is to its customer not the enquirer and that this is an opinion not a guarantee. The bank is not underwriting the credit application.

Bank references should only be used for small value decisions or to support other reports.

Credit reference agencies

If the customer is a limited company (and if they are, they have to disclose this fact on all business stationery), they will have to file annual accounts at Companies House and, for a fee, you can access these accounts. Unfortunately many smaller companies can file abbreviated accounts and you’ll probably need an accountant to translate them.

The solution is to approach a credit agency and get them to do the analysis for you. For a fee the agency will be able to give you all of a company’s background information - names of directors and so on, as well as a brief financial analysis of the company's financial status, details of any county court judgements against the company and details of any borrowings. You will be asked how much credit you intend to extend to that company and given an assessment of the risk involved.

In an ideal world, of course, you would only deal with customers who retuned a perfect credit history when checked. Few companies have the luxury of being able to do that. Credit checking allows you to make calculated decisions so you minimise the risk of trading on credit.