Credit & Collections For Small Business BUS 204 Credit & Collections Spring 2006 copyright, SJH
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..Trustingthat 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 back. • To make a profit from the interest. • For cash flow reasons.
Credit as aPricing 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 • Loss of customers to competition • Lack of customer satisfaction • Not tapping into “impulse buy” • Not the industry standard • Missing out on the “Charge, charge, charge!”
Guiding Principles for Extending Credit…Factors to Consider • Your Industry- is it custom in your industry to extend credit? • Your Customers- Are you dependent on 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 OptionsCredit comes in many shapes & sizes.. • Offer to accept checks (still involve a risk) • Offer to accept credit cards • Credit Terms (B2B or Wholesale) • Offer a revolving charge account • Offer installment accounts • Enable customers to 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 big-ticketitems. The monthly payments include 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”
Standard Sale Sales $ Layaway Garment 100 Total Sales $ 100 Cost of Sales -60 Gross Profit $ 40 Layaway Sale* Sales $ 20 Layaway Garment 100 Total Sales $ 120 Cost of Sales -60 Gross Profit $ 60 * Layaway with 1 payment Standard Sale VS. Layaway Plan
Progress Payments • The customer pays for a certain percentage upfront (33%) when signing the agreement. • As the “project” progresses the customer pays for an additional amount (33%). • 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 CardsThe 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 WorksIn a nutshell • 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 goods. 2) The Cardholder never ordered the goods (stolen credit-card). 3) The Cardholder returns the goods.
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 Information Form • Purchase Agreement or Purchase Order • Loan Agreement • Security Agreement (if loan is collateralized)
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 office stores - • A full loan application should have the following elements: Name and street address (not PO) Does the applicant own or rent? Does the applicant have any other real estate? Name, address and phone of employer Identify all checking & saving accounts
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.
Trade Credit • Business to business • Use with suppliers or wholesaler • C.O.D. Cash on Delivery (no extended credit) • 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 • F.O.B shipping point the buyers pays all transport charges • F.O.B. destination the seller pays all transport charges • List Price the original price from which discounts are taken • Trade Discountreductions from the manufacturers list price