How to do a credit check on a customer

Selling on credit means handing over goods or finishing work before you are paid. business.gov.au notes that credit is common between businesses and can help sales, but that a customer who pays late, or never pays, can hurt your cash flow.

Its suggestions for keeping that risk down include checking a customer before credit is given and capping how much each customer can owe. A credit check covers both, and answers whether this customer should get credit at all, how much, and on what terms.

Write down when a check happens, so it doesn't depend on who takes the order. A simple policy covers:

• every new customer who asks to pay on account, before their first credit sale
• an existing customer who asks for a higher limit or longer terms
• a customer whose payments have started arriving later than they used to
• a customer whose business has changed hands or changed its name.

Customers who pay up front, or at the time of sale, don't need a check, because no credit is involved.

A short application form gives you the same information from every customer and a signed record of what they agreed to. It usually asks for:

• the customer's full legal name, any trading name and their business address
• the name, email and phone number of the person who pays their bills
• the names of other suppliers who give them credit, to use as trade references
• the limit they are asking for
• the signature of someone authorised to agree to your payment terms on their behalf.

Attach your payment terms to the form, so the customer sees them before they sign.

Start by confirming who you are dealing with. business.gov.au suggests knowing who a business is before you enter into an agreement with it, and points to ASIC's guidance on dealing with businesses and companies. Its guide to choosing suppliers lists basic checks, such as reading reviews, asking for references and searching the Australian Business Register to confirm a business is legitimately registered. The same checks are useful on a new trade customer.

Then call the trade references. Ask how long they have given the customer credit, roughly how much, and whether the customer pays by the due date. A reference that is slow to answer, or vague, tells you something too.

business.gov.au's glossary describes a credit history as a report on a person's or a business's past credit arrangements, and a credit rating as a ranking drawn from that history that represents their ability to repay. It points to ASIC's Moneysmart website for more about credit reports.

For a customer you already deal with, look at your own records first. How many days after the due date their invoices have usually been paid, and whether any were disputed, is direct evidence of how they handle your account.

The answer doesn't have to be yes or no. Depending on what the check shows, you might offer credit at the amount asked for, a lower limit, shorter terms, or no credit until the customer has a payment history with you. business.gov.au's cash flow guidance mentions deposits for special orders, and its funding guidance suggests asking larger business clients for a deposit up front.

Put the terms on your invoices and in any contract. If you're unsure what terms to offer, business.gov.au suggests asking your industry association or a business adviser.

• Enter the credit limit and payment terms on the customer's record, so each invoice takes its due date from the terms agreed.
• Note the date of the check, who approved the limit and the reason for any conditions.
• File the signed application and your notes from the reference calls with the customer's other records.
• Before accepting a new order on credit, add it to unpaid invoices and other accepted orders not yet invoiced, counting each commitment once and allowing for payments already received. If that exposure would exceed the limit, ask for payment or agree a revised limit before supplying.

Credit checks are a starting point. After that, your receivables show how each customer actually behaves. business.gov.au lists customers often paying late, leaving you short of cash to cover costs, among the signs of a cash flow problem.

Look at each account customer's limit and payment record regularly, and straight away if their payments slip, they ask for more credit or they place an unusually large order. Lowering a limit or shortening terms is easier to explain when the change is based on the customer's own payment record.