The Pros and Cons of Offering Credit to Customers + How To Get Started

Credit
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March 1, 2023
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7
 min read
A woman learns about the benefits of offering credit to customers to improve her business.

Offering Credit Explained

Businesses that offer credit gain a competitive edge over their rivals and have increased opportunities to work with customers. To accomplish this, they need to create a comprehensive credit policy to preserve their cash flow.

Solely accepting cash up front for your sales is a safe practice, but it’s severely limiting to your business. Sticking to one payment method pushes customers who need flexibility to your competitors.

Offering credit options can prevent that outcome while leading to a host of other benefits. However, it does expose your business to added risk, so it’s important to research the possible repercussions.

6 Pros of Offering Credit

An image provides the six main benefits businesses can gain by offering credit

The advantages of credit for businesses are often too good to pass up. Here’s a rundown of what you stand to gain by offering credit to customers.

1. It Provides a Competitive Edge

Customers seek out businesses that offer credit due to the benefits it provides to their own cash flow. If your competitors do not offer credit, you can gain an edge over them in the market by doing so.

On the other hand, if your competitors offer credit, your business will need to offer at least the same credit terms to appeal to customers. You’ll need to offer even better terms to maintain that competitive edge.

Nuvo Tip:

79% of consumers expected large national companies and local service providers to have the same payment options.

2. It Expands the Potential Customer Pool

Aside from simply appreciating the option of buying on credit, some customers require credit purchases to stay operational. Offering credit to customers can lead to increased sales by making your services affordable. Otherwise, you’ll be excluding a large portion of the market, limiting your sales to fewer customers.

3. It Enables More Frequent Purchases

Just as some customers need credit to make purchases, many like having the option to make a purchase when they need to, not just when they have the cash on hand. Offering credit allows them to pay with the revenue generated from a later sale. Without the option of credit, their cash reserves may not enable them to buy from you, leading to the possibility of them going to a competitor who offers credit.

4. It Boosts Customer Loyalty

Extending credit to customers is a show of trust between you, indicating you believe in their business and respect them. Customers often reward this sign of confidence with continued business, not wanting to burn bridges with a company that’s facilitating their success.

Nuvo Tip:

In 2016, nearly three-quarters of consumers said their satisfaction with a company could be improved by having multiple billing and payment options.

5. It Strengthens Your Company’s Reputation

Word spreads fast when a company offers a great deal, the same way people tell their friends when a sale is going on. Extending credit allows your customers to talk to their peers, providing publicity for your company. Getting the market to talk about you in a positive light is a great way to improve your brand.

6. It Displays Company Stability

When a company first gets up and running, they’re likely operating on thin margins, making it difficult to offer credit to customers. This is also when the company is at the biggest risk of going out of business.

Customers are usually looking for long-term relationships with their suppliers. By being able to offer credit, you’re showing your business is stable and will be able to work with them for years to come.

5 Cons of Offering Credit

An image provides the main risks a business is exposed to by offering credit

Despite its many benefits, there are some disadvantages of offering credit.

1. It Puts Your Cash Flow at Risk

The natural result of offering credit to customers is that you will have access to less cash at any given time. With product leaving faster than cash is flowing in, you may not be able to replace your inventory or cover expenses immediately. You can mitigate this by keeping a close eye on the amount of issued credit and adjusting your offerings accordingly.

Nuvo Tip:

In 2020, it took more than 20 days for 80% of businesses to collect outstanding receivables.

2. It Increases the Occurrence of Delinquent Accounts

Regardless of how tight your credit policy is, you’ll still run into customers who fail to uphold their payment terms and miss due dates. This can exacerbate the issue if your cash flow is already small due to offering credit. One way to handle this issue is by having an effective dunning process that increases your chances of successfully getting paid.

3. It Can Lead To Costly Collection Fees

If customers fail to respond properly to your past due notices, the next step will be sending the invoice to a collection agency. With a little luck, you’ll be able to recoup some of the debt, but not all. You may even take the customer to court if the debt is large enough, adding in costly legal fees.

4. It Increases Pressure on the Accounts Receivable Department

Offering credit adds a number of extra processes that your accounts receivable team will have to execute. You may need to hire new employees to help with the added responsibilities, like approving credit applications and issuing invoices and keep the team from being overwhelmed.

5. It Can Cause Your Company To Have Bad Debt

Overdue invoices can create a snowball effect hurting other areas of your business. Even one missed payment can lead to costly bad debt if your product is expensive. Bad customer debt will make it harder for your company to cover its own debt.

How To Determine If You Should Offer Credit To Customers

The benefits of offering credit to customers usually outweigh the risks for businesses, so it’s important to research if it’s the right decision diligently. Here are some ways to help determine that:

  • Can your cash flow accommodate it? To offer credit to customers, you’ll need to dependably have enough cash on hand to cover your expenses while waiting for payments.
  • Do you have a large pool of clients? The smaller the number of clients you have, the riskier it is to offer credit since you’ll have fewer payments coming in at any time. 
  • Can you handle delinquent accounts? Missed due dates will happen on occasion. You’ll need to be able to cover these interruptions in your schedule for credit options to be successful.

If you answered yes to all of these questions, then your company may be able to start issuing lines of credit.

How To Get Started Offering Credit Terms (And How To Reduce Risks)

An image shows 4 best practices for offering credit to customers to achieve success

How you launch your credit offerings will set the stage for its long-term success, so getting it right from the start is important. Here are some ways to make sure that happens.

Develop a Credit Policy

A credit policy provides a clear point of reference for everyone in your company to remain aligned. It should cover how to vet applicants, how to issue credit should, payment terms, and team responsibilities.

Conduct Background Checks

Once your credit policy is in place, you’ll need to conduct background checks on every customer seeking a line of credit. You’ll want to pull their credit score from a trusted source, follow up with their provided trade references, and look into their banking history. This is all necessary to get a full picture of what to expect from them in the future.

Monitor Customer Activity

Even after you’ve conducted a background check and approved a customer, you’ll still want to keep an eye on their financial activity moving forward. A customer’s status will likely change, and you’ll want to act quickly to avoid issues. If a customer’s credit score drops, you’ll likely want to drop their credit limit to a more reasonable level. If their score increases, you may want to increase their limit to take advantage of their situation and keep their business.

Offer Discounts For Early Payments

Just because you give someone up to 30 days to pay doesn’t mean it has to take that long. Offering discounts for people who settle their accounts early is a great way to keep your cash flow healthy. It will also make the client less likely to miss a due date since they have more to gain by making the payment. 

Offering credit can be a daunting task for any business, but its benefits make it well worth the work. To help safeguard your cash flow and streamline the process, check out what Nuvo can do for you.

Offering Credit FAQs

Here’s some additional information to help decide if offering credit to customers is right for your business.

How Do You Offer Credit to Customers?

You can offer credit to customers by:

  • Sharing your credit policy with them
  • Having them fill out an application
  • Performing a credit check
  • Having them sign an agreement

How Do You Determine Customer Credit Terms?

Credit terms are often determined based on the following criteria:

  1. The customer’s payment history
  2. The length of time they’ve been a customer
  3. The current state of your cash flow
  4. Competitor credit terms

What Are the Four Types of Credit?

The four common types of credit are:

  • Revolving credit: a lender sets a credit limit, and the borrower's balance rolls over each month until it is paid off
  • Installment credit: has a set borrowing amount with a defined timeline for repayment, like a car loan
  • Noninstallment credit: enables borrowers to use a service and pay for it at a later date, like electricity.
  • Charge cards: similar to revolving credit, but the balance must be paid in full and on time each month to avoid accumulating fees

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