Credit Extension Best Practices
Credit Extension Best Practices
Notes from the Webinar:
Rule Number 1:
⁃ Extend credit with terms that only make you comfortable
⁃ If the lendee is asking for too much tell them those aren’t acceptable terms.
⁃ You are the lender, you get to set the terms
Rule Number 2:
⁃ Do your diligence
⁃ Ask for the company’s financials
⁃ certified by a CPA
⁃ Run a credit check on the business and the business owner
⁃ Use resources available
⁃ Dunn & Bradstreet
⁃ Much of this doesn’t apply to us in the cannabis industry but its always worth taking a quick look. If a resource is there to use, use it!
⁃ The more effort given in gathering information at the beginning of a business relationship can mean less effort required to collect money later.
Rule Number 3:
⁃ Information to Gather
⁃ Date of application
⁃ Customer’s full legal name, trade names or DBAs
⁃ Part of the function of a credit application is that of a legally binding contract. Therefore, the information must be correct.
⁃ Any and all addresses associated with the business including physical address, PO boxes, and billing and mailing addresses. Use caution if a mail drop is offered as an address. Consider it a red flag for possible fraud.
⁃ Contact information
⁃ Email addresses, telephone numbers (landline and cell) and fax numbers.
⁃ FEIN Federal Tax ID numbers
⁃ Number of years in business
⁃ Long-time established businesses generally present less of a credit risk.
⁃ Sales tax exemption
⁃ If this is applicable, the creditor should request a sales exemption certificate.
⁃ Lease or own
⁃ This information is especially useful if the creditor/customer relationship deteriorates to the point of legal intervention.
⁃ Legal status
⁃ It’s important to identify the type of company to which credit is being extended. The legal status will dictate the person/s liable for debt. The three main types of companies are:
⁃ 1. Sole proprietor
⁃ The owner and the business are one in the same and therefore liable for debts incurred by the business.
⁃ 2. General partnership
⁃ Regardless of the number of partners in a general partnership, a creditor can approach any one of the general partners to satisfy a debt. Partnerships may include limited partners but a creditor may not approach limited partners to satisfy a debt.
⁃ 3. Corporation
⁃ Operates with the rights and privileges of the laws of the state in which it operates. The corporation itself is liable; shareholders aren’t liable for debts incurred by the corporation unless they sign a personal guaranty. (LLCs and S-Corps are included in our definition of “corporation”.)
⁃ Antecedent information is the information gathered about principals, owners, officers and members of a business entity. It is the antecedents that often determine business successes or business failures, therefore their business history will be useful to credit managers in weighing the risks of extending credit.
⁃ Related ventures
⁃ The history of business ventures of the applicant may reveal a pattern that is helpful in weighing the credit risk. This includes the type of business and how the business ultimately ended (bankruptcy, buy-out, etc.).
⁃ Bank references
⁃ Creditors must communicate with the applicant’s bank directly. To do that, it will be important to have basic contact information available like bank name, address, loan officers name, phone numbers and email addresses. Creditors will also need the applicant’s bank account number.
⁃ Trade references
⁃ It’s standard to ask for trade references. It’s also typical that the references provided by an applicant will be ones that are slanted in the applicant’s favor. So, while this is good information to have, it’s certainly not the only information upon which to make a credit decision. Trade references are just one of the many pieces of information that will help a creditor make a good decision.
Rule Number 4
⁃ Establishing Credit Terms
⁃ The 5 C’s
⁃ Morally speaking, does the applicant appear to be the kind of person that will pay what is owed?
⁃ Does it appear that the applicant has the ability to pay?
⁃ When a creditor considers the capacity of a new customer, there are two main questions to answer:
⁃ 1. Is this company operating profitably or have the potential to do so?
⁃ 2. Is this company healthy enough to experience profitable growth?
⁃ Does it appear that the applicant has financial strength measured by net worth or equity?
⁃ Does the applicant appear to have possessions like inventory, equipment or property enough to cover an unpaid debt?
⁃ Does it appear that current economic or industry conditions will affect your applicant favorably?
Rule Number 5
⁃ Evaluate The Risk
⁃ Questions to ask yourself during credit analyzation:
⁃ 1. How much credit will be needed?
⁃ 2. Do they have enough cash on balance sheet to cover their debt?
⁃ 3. What is the profit margin on the goods being sold?
⁃ 4. Can the customer pay?
⁃ 5. Does the customer have a track record of paying?
⁃ 6. Is the use of credit a substitute for a bank loan?
⁃ 7. Is the customer at risk for a being slow-payer? If so, why?
⁃ 8. Maybe the customer doesn’t presently have the resources to pay. But does it appear that he will by the time the bill comes due?
⁃ 9. What are other creditors offering this customer?
⁃ Spotting the high-risk customer
⁃ Failure in one or more of The Five C’s
⁃ Strings of broken promises unveiled by a bad track record indicate a break in character. Misleading statements should be seen as a warning sign. Always remember, credit is about faith and trust.
⁃ Chapter 11 bankruptcies present a very high risk for the creditor. Any number of things could have lead to the bankruptcy, even something that’s not the customer’s fault. But no matter what lead to the circumstance, clearly the customer is in financial straits now.
⁃ Balance sheets and operating statements
⁃ Balance sheets and operating statements that reveal a declining net worth represent high risk. Operating statements put a spotlight on declining sales and/or profits. So, while you and your customer may have started out on strong footing, the earlier you spot the decline, the more quickly you can take action.
⁃ Credit reports
⁃ Credit reports pull back the curtain on changes in payment habits. The customer whose habits have declined presents a higher risk.
⁃ Payment History
⁃ Spotty, shotty or outright negative history might go beyond late payments. If a customer has been known to lie or if they frequently pass NSF checks, the credit risk is extremely high.
⁃ Past Due Accounts
⁃ How a customer manages cash flow directly impacts your bottom line when you extend credit. Keep records that show at a glance when an account is current or past due. This will make it easy to spot changes or patterns in payments.
⁃ Unexpected occurrences
⁃ Keep an eye on the customer’s industry or the current events that may have an impact upon it. With even a basic grasp on the types of things that influence sales, a credit professional can stay one step ahead of possible future issues
Rule Number 6:
⁃ Securing your extension
⁃ Always make sure to secure your credit extension
⁃ Require one or multiple of the following:
⁃ Personal guarantee from the business owner
⁃ Collateral to secure the debt
⁃ Land, Inventory, Equipment
Rule Number 7:
⁃ Common mistakes to avoid
⁃ Acting quickly and w/o due diligence because you’re worried about losing the sale
⁃ Coming to terms on a handshake deal
⁃ Always get it in writing!
⁃ If you think they won’t pay, DO NOT EXTEND CREDIT
⁃ If you give them product and they don’t pay, it will cost you far more time and money trying to collect it, then it would finding a new customer to sell
⁃ Always secure the credit with some additional means to collect
⁃ Most importantly, trust your gut! Human intuition is a powerful and mostly accurate thing