6 Steps to Manage Credit Extensions When Scaling Your Business

When dealing with credit extension requests, it is essential to structure a risk analysis process to protect our business.

There comes a point in time when our business needs to scale by attracting the attention of several customers. When customer acquisition becomes the main objective of our strategy, we may find ourselves dealing with credit extension requests. At first, it may be very tempting to satisfy all these requests in order to grow our customer base. However, it is essential to perform a rigorous risk analysis without being biased by our goals. Indeed, a loose credit extension program may benefit our revenues in the short term while threatening the financial stability of our business in the long term.

The credit extension dilemma

I manage a B2B SaaS travel business and right after launch (4 years ago) our main objectives were to grow our customer base and get enough feedback to improve the software. While our main form of payment was through credit card, we immediately received several requests of credit extension since our competitors were already providing this extra service.

Being travel services quite expensive, we estimated that a few clients would need a credit extension up to 50.000€ a month. This is a lot of money for an intermediary that works on tight margins. Hence, we decided to establish an internal credit analysis in order to reward only “good” customers among the many that required a credit extension.

In these 4 years we grew our customer base to more than 2.000 B2B customers, but we gave a credit extension only to 10% of them. Throughout time, we discovered that this percentage was good enough to keep our risk below 1%, while extending credit to 20% of our customers would have increased risk by 12%. Below you will find some useful tips on how we managed to minimize risk with 6 simple steps that you can adopt immediately for your business.

1. Perform credit checks

This is the first and most essential step to start minimizing credit extension risk. Nowadays almost all businesses in every country are required to issue financial statements and there are several platforms that make them available to the public. Many of these platforms require you to pay to access the information they provide, but trust me, the money is worth the benefit. I suggest you look for the best option based on where your business operates since there are many of these platforms.

Within the platform you can access financial information on your B2B customers and find their financial rating (which usually goes from 0 to 100 or from 0 to 10), their financial statements, their ownership structure, and many more details. Just with this brief information you can define in which risk range your customer falls and act accordingly.

2. Get a Credit Insurance

Let’s say you have just checked your first client and their financial rating is 8 out of 10. This is a very good rating and you can assume that your client is financially stable and is eligible for a credit extension, right? Not exactly.

Financial statements, as you probably know, may be altered so we need to rely on another piece of information which is the transaction reliability. By transaction reliability I mean the probability that your customer will pay and will also pay on time. Some platforms may give you this information, but the most reliable sources are and will always remain credit insurances.

Credit insurances give you the possibility to insure all your credit extensions, provided that you give them the names of your customers in order to verify their credit risk. While your “good” customer may have good financial statements, you may not know that they always delay payments up to 60 days because their cash flow is not stable. This is an information that only credit insurances have. Why? First, they insure your credit extension so they need to verify if your customer will pay, and second, it is expensive to have this kind of information network. Hence, many platforms do not have reliable data on transaction reliability even though they show it.

The cost of a credit insurance depends on the insured volume and credit risk of your clients, but it will be around 0,3% to 1% of your transacted volume. Of course, if a potential client has a credit risk of 3, the credit insurance will not allow you to extend credit.

3. Start small and then increase

Even though you are insured, you may want to get to know your clients before allowing big credit extensions. Credit insurances will pay your missed payments only after 120 to 180 days and will also reconsider the cost of the insurance if many of your clients default.

Even though it is tempting, it is very risky to allow big credit extensions to new clients. They may have a perfect financial rating and promise you to pay on time, but you will soon find out that you need to call them 10 times a week in order to receive a payment. Remember that clients that are desperate for a credit extension are usually in a fragile financial situation with a very slow cash flow.

4. Make your payment cycle faster

Ninety days credit extensions are eligible only in industries with high margins. If you are not in one of these industries, try to make your payment cycle by invoicing clients every month, or better, every fifteen days.

Our business went from a 30 days credit extension with monthly invoicing to a 15 days credit extension with fortnightly invoicing. Of course many clients tried to negotiate the terms, but they eventually accepted the change because what they really cared about was the quality of the service we provide.

By reducing the payment cycle we were able to spot immediately trouble makers and block their credit extension. Indeed, if you talk to a credit insurance they will tell you that “bad” customers try to delay payments little by little in order to create an increasing debt spiral that you will not be able to manage. Once a client starts accumulating debt, you will keep providing services with the expectation that these debts will be paid soon. Unfortunately, that’s how many businesses fail.

5. Perform a monthly credit risk analysis

You should keep a file with just four rows: name of the client, financial rating, credit extension (in €) and credit insurance (yes or no). With just a simple file you can make your credit analysis in a few minutes. Even better, some CRMs or accounting softwares allow you to keep track of credit scores. If that’s your case, then you are already set up.

First of all, cluster all your clients with the same financial rating and visualize the results with a table. If you see that the majority of you clients fall in the high risk category, you are not selecting your clients well and I hope you are not giving them credit extensions.

Compute the total of your credit extensions and see how much money you are leaving behind. If you cannot sustain this kind of financial stress or you are worried when you see your total exposure, you should immediately change strategy and reduce your risk.

If you calculate the mean of the financial rating column and the mean of the credit extension column you can have a very quick picture of the success of your credit extension process. A very successful process should see the first number increasing over time, meaning that you are giving credit extensions to healthy businesses.

Remember that Pareto’s Law can be applied to this analysis. Let’s assume that you are extending credit to 100 clients and 20% of these clients make up for 80% of your revenue. Is it worth to extend credit to the remaining 80% of these clients? If you want to spread the risk by diversifying your client portfolio, the answer is yes, but if you want to have less financial stress, the answer is no. Hence, act accordingly based on your overall strategy.

6. Always think about your business first

This is definitely the most important point even though it may sound very common sense. I know from experience that scaling a business requires many sacrifices and often revenue becomes our main objective at the expense of our financial stability. When this starts to happen, take a step back and think about your business, your employees, your dreams.

It takes one second to go from hero to zero if your cash flow is not safe and stable. Credit extensions are essential to deal with important clients, but this does not mean that you should satisfy all their requests. We have turned down many requests that were not meeting our payment terms because for us cash is king and, up to now, this decision has made us lose only 15.000€ (which have been reimbursed by the credit insurance) on a yearly transaction volume of more than 15 million €. This means that our risk of losing money due to credit extensions is 0.1%.

Conclusion

As we have seen, there are several actions you can take to manage your credit extensions and, at the same time, to minimize risk. These are the foundations of what your credit extension process should look like, but there are definitely more advanced analyses that you can explore.

In my experience, these 6 simple steps have saved us a lot of trouble and helped us improve our financials. The amount of risk you can take depends on many variables such as your margins, profits, cash flow, client portfolio, industry, etc. Our business needed to structure a very rigorous credit extension process because the margins in the travel industry do not allow for these kind of mistakes. If your business can tolerate a higher risk level and you see that credit extensions allow you to land more clients, then go for it. Just remember to prepare yourself with the steps we have discussed in order to preserve your financial stability.