Business credit applications are critical to help businesses assess and manage credit risk because they will, if you use them correctly, help you identify companies who you may want to be careful with when extending credit. Most companies don’t use business credit applications and even those who do use them don’t follow up on them after they’re filled out or ask for the additional information required to truly understand the risk involved, are you?
Learn more about business credit applications below, best practices for follow-up, financial information to analyze, and how to manage these important documents for reduced credit risk.
WHAT TO INCLUDE IN A BUSINESS CREDIT APPLICATION
Business credit applications can be as simple or as complex as you’d like. At the very least, they should require the applicant to give you the following information:
- Name of the business, address, phone and fax number
- Names, addresses, Social Security numbers of principals
- Type of business (corporation, partnership, proprietorship)
- Number of employees
- Bank references
- Trade payment references
- Business/personal bankruptcy history
- Any other names under which the company does business
This would be considered a pretty basic credit application, a more comprehensive application will give you a better idea and more confidence in your decision; and that requires more information. For a more complete application, you might want to ask for financial information that will allow you to evaluate the following:
Evaluate the expenses and revenues of the customer, are they making money?
Run the following financial ratios to help determine the financial health of the potential borrower:
- Debt to equity ratio
- Debt to asset ratio
- Current ratio
- Quick (acid test) ratio
- Operating cash flow ratio
- Working capital ratio
Does the borrower have a healthy cash flow from operations, investing, and financing activities? Their cash flow will impact yours, so you want to make sure they have money coming in.
Find out how much debt the potential borrower has and decipher how much they can afford based on the other financial information you’ve seen. If they look like are in over their heads, you may want to be careful about offering credit.
What is the normal debt/liquidity level for companies similar to this borrower’s size in their industry and how do they measure up?
If you decide you do not want to ask for that financial information on your application, you can always purchase a commercial credit report on the potential borrower which would have all of that information included, but that can get pricey over time. Business credit applications should be used for new customers as well as repeat customers if it has been a long time since you last checked their creditworthiness, or if they are asking you to increase their credit limit.
BUSINESS CREDIT APPLICATION BEST PRACTICES
We’ve all done it, we send out the application which is then filled out and returned, and we don’t follow up the references provided. This is a common and costly mistake that credit professionals everywhere make. Always follow up with trade references provided in the credit application and don’t be afraid to ask the customer additional questions either. Below is a list of things you may want to ask during conversations with the trade references or with your potential borrower themselves:
WHAT TO ASK WHEN YOU SPEAK WITH A TRADE REFERENCE
- Is there a pattern of paying some suppliers on time and some late? Why is this? Is it seasonal?
- Is there chronic delinquency or is it sporadic, are there any patterns?
- Is there a seasonal pattern? (this can be worked around)
- Have they had any bad checks?
- Do they order and/or pay consistently?
QUESTIONS TO ASK THE CUSTOMER DIRECTLY
- Is a poor payment history due to employment issues, a one-time event, a personal reason, etc?
- Is cash or COD acceptable with the customer until or if credit is approved?
- Where is the business going and how long has it been in business?
- Who are their customers?
- Does the customer sell on credit to their customers? Do they have credit risk management procedures in place?
- Does the company have any suits, liens, bankruptcies, U.C.C. filings or judgments against them?
MANAGING CUSTOMER CREDIT APPLICATIONS
Sending, receiving, and organizing important documents like a customer credit application is important to make you know that you have the completed document, when it was completed, and that it is being stored securely. That can be tough when you have so many applications to keep track of and an endless number of other credit management tasks to do; so we’ve made it easy. An automated accounts receivable management tool usually has a document management features that not only allows you to save and organize your customer credit applications, it allows you to:
- Save a template in the system to cut down on time spent creating and editing one.
- Send it to customers and receive the completed document through encrypted emails or through a secure customer portal.
- Manage, store, and share other important documents such as invoices, proof of delivery, time sheets, and other documents.
You can also set up the software to notify you when it has been X days/months/years since a customer has filled out a credit application or since you have run a credit analysis on a customer to make sure your company is always protected against credit risk.