Most people hate chasing money. Poor cash flow is a common reason for business failure, and unpaid invoices are a huge cause for terrible cash flow. Below are three ways a credit application can help startups avoid cash flow problems, from how to evaluate a customer’s credit worthiness and establish payment terms to protecting yourself in case of default.
Avoiding business failure
Starting a business is exciting; but not everything about owning your own business is great.
According to Lending Tree, 20 percent of new businesses fail in their first year, and only 35 percent make it to a 10-year anniversary.
Poor cash flow is a big reason that businesses fail, as it leaves your business unable to purchase needed supplies, pay employees or pay your own bills. Unpaid invoices are often the cause of poor cash flow. You might be surprised to learn that a credit application can help you avoid this common scenario.
Many entrepreneurs never think about credit applications because they don’t see themselves as loaning out money. However, if you complete work for someone or send them a product before being paid in full, you have actually loaned that person money. A credit application can help your business by determining your customer’s credit worthiness, establishing payment terms, and providing information and protection if your customer defaults on the agreement.
Evaluate your customer’s credit worthiness
Any time you work with a new client, you should require basic contact information including name, address, website, phone number and information about any parent companies. You should then confirm that all of this information is correct before moving on to a credit application. The truth is, business fraud exists in many ways, and fraud is the root cause of many unpaid invoices. Checking the basic information that you’re given can be your first step in helping you avoid being a victim.
To evaluate credit worthiness, you will need references and bank information. Credit reports are fairly inexpensive, especially when compared to the cost of doing business with a fraudulent company. It’s important to remember that even well-known companies can be credit risks. If you find that a company is a bad credit risk, but you still wish to do business with them, you could protect yourself by asking for a larger deposit before beginning the work.
Related: Get Funded with Bad Credit
Establish payment terms
You can establish payment terms in your credit application. You don’t want to make the application too long, but including payment terms provides an extra layer of protection if there is a disagreement in the future.
It’s important that any terms in your credit application match what is on your contracts or invoices. If you change your payment terms, make sure to update your credit application.
If you include payment terms, you should also include the term “Binding Agreement.” This lets the client know that in completing the application, they are agreeing to the terms you set forth.
You should also include an “Authorization to Bind” clause. This clause states that the person filling out the form (thereby agreeing to your terms) has the legal right to do so on behalf of the company. Businesses often try to get out of paying a contract by claiming that the person who entered into the contract did not have the right to do so. Including this will protect your business.
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Protect yourself in case of default
There are many provisions that you can include on a credit application which will give you leverage when dealing with delinquent accounts.
These terms include:
- Personal guaranty: An owner taking personal responsibility for a debt
- Interest: The right to collect interest
- Acceleration: If a customer is in breach of the contract, all the money they owe you becomes due. This is especially important for companies that charge monthly or quarterly for an annual contract
- Collection costs: If you have to send the account to collections, the client has to pay the cost
- Attorney fees: If you have to sue, the client owes the cost of the attorney
Having these terms included in your credit application may put you at the top of the “to pay” list for a client with financial difficulties. However, not every client will agree to all of the clauses or terms you want to include in your credit application. If a client asks to remove a clause, make sure you understand why they want the term removed. You can always evaluate the situation and remove items on a case by case basis.
As a new business owner, you’re likely to fill out credit applications yourself. In that case, make sure you fully read and understand any terms to which you agree.
When you started your business, you likely created a business plan and a marketing plan. Having a plan to keep your cash flow healthy is equally important, and a credit application can be a good step in the right direction.
