Don’t downplay the risks of extending credit to clients
It’s tempting to be the nice guy. The one who gives a twenty to a lonely stranger at the bus station who just needs a ride. The one who lends the wacky uncle a couple thousand for that “can’t miss” investment opportunity. The one who funds a friend’s Kickstarter, just because.
That temptation comes in business as well. Extending credit to a valued client can build customer loyalty, encourage larger orders in the future, and provide a competitive advantage in the marketplace. It also feels good to help a struggling company that might just be starting to build credit. And they may even do you a very real (and profitable) solid in the future.
But lender beware. The risks of behaving as a de facto bank to your customers are real and often underestimated. Keep the following mantras in mind when you consider this type of arrangement.
You are not a bank
Once you extend credit to a client, your relationship changes. You are no longer just their supplier or service provider. You are their bank. And banks have needs that are likely far different than those of your business. Neither you nor your staff signed up to be the local Savings and Loan.
Sure, most of your customers are reliable, trustworthy folks. They will pay you back in full and on time. Except when they won’t – 41 percent of small businesses say invoice payment collection is their single largest cash flow management challenge. A client that pays late now has a no-interest loan with better terms than any real bank would provide.
You put your own business at risk
Once you commit to this new role as lender, the risks to your own business’s bottom line will begin to seep into your balance sheet. Consider these stark possibilities:
- You now provide your services for free.Your costs don’t disappear just because you decide to be benevolent. You still have employees to pay, lights to keep lit, and maybe investors to reassure. Meanwhile, your borrowers have free services and free money, for a period of time.
- Your own line of credit could be at risk.It’s easy enough to tap your own pot to lend someone a hand, but you are still on the hook for the interest, or simply the time value of money and the opportunity cost of each missing dollar.
- Your vendors may start to get antsy.If your cash runs short because of these loan commitments, it may be tempting to pass the burden on to your own vendors and suppliers. They may not share your affinity for banking and may not stick around. But you’re a valued customer, so of course, they will understand. Oh, wait. Is this starting to sound familiar?
Add to these factors the added cost to collect on these outstanding loans. More paperwork to send additional invoices. More time on the phone making collections calls. Less time working for your own financial interests. You are no longer feeding the business and it could begin to show signs of starvation.
Cash that should go towards an amazing new hire or a critical system upgrade – or the rainy day fund – now slips down the drain of bank-like responsibilities.
Respect yourself and others will, too
A “Nice Guy” credit policy may bring smiles in the short term and unforeseen and poorly quantifiable benefits in the longer term. But a careful and clear credit policy will earn the respect of your staff and those clients who truly understand your expertise. And it may even attract new customers with shared values.
Put everything in writing and trust your intuition. A handshake is great at the networking breakfast, but dangerous in the marketplace.
When clients start to take advantage of your generosity, when payment deadlines start to slip, and when calls go unanswered, it’s time to respect yourself and take a stand. Draw that line and step behind it. Rest assured, they will pay attention and put the check in the mail. Or they will show their true colors.
And if they can’t pay on time, your business is better off without them.
Profit Point Consulting’s mission is to accelerate the growth of small and medium-sized companies through sound, strategic advice, and proactive financial management. If you need a trusted advisor to help develop and execute your vision, call us at (973) 659-1430 or fill out our contact form.