Why Sell on Credit?
Most small-business owners do not want to deal with all the expected hassles that come with offering credit to customers. Most of them also realize that in today's highly competitive markets, extending credit (at least to some customers) can be essential to success. Many drag their feet, thinking about setting up a credit system only when they absolutely have to, and often without much planning. Although it's very common for businesses that sell to other businesses to extend credit to their customers, you can offer this convenience to individuals as well.
To make credit work for you and your business, figure out what you want to do before you get stuck extending credit haphazardly. That way, you will be able to spend more of your time growing your business than chasing after customers for payments. Plus, having the right credit policies in place can give your business a huge sales boost.
Any time you let a customer pay with anything other than cash, you have extended credit. Even though sales that are paid with credit cards or checks on the spot are recorded on your books as cash sales, they technically are still forms of credit, as your business has not yet received any money.
Keep in mind that offering credit may not make sense for your business, or at least not right now. Your company does not have to extend credit just because many other companies do; the decision should be based on what works for your company's unique circumstances.
Whether to offer credit depends on four factors:
Typical transaction size
Your financial situation
None of these factors should be looked at in a vacuum. Rather, consider all of them in connection to your business circumstances. That will help you make the best decision for your company.
The Business Side
First, look at your customer relationships. When your business depends on repeat customers, extending credit is a simple way to keep them happy and loyal. Knowing your customers well (as happens with repeat customers) also lends itself to offering credit; the closer the relationship, the more likely you are to get paid regularly and on time. Then there are your customers themselves: when your customers are well-established and financially stable, you are more likely to let them buy now and pay later.
Next, find out what the industry practice is. If offering credit is the standard, you may have to follow along to attract customers. In industries where it's rare to offer credit, you may decide to do it anyway to give yourself a competitive edge. Sometimes the industry standard will be crystal clear: for example, ice cream shops don't normally offer credit for cone purchases, but car dealers almost always write up credit agreements. Other times, the answer may be fuzzy, and the other factors will play a bigger part in your decision.
The Money Side
The size of an average sale is next on the consideration list. When you have a lot of tiny transactions, credit may not come into play at all. Bigger transactions (in money terms) often lend themselves to credit terms, as in the ice cream cone versus car example.
Finally, your company's financial situation will play a role in your decision. Having ample cash reserves gives you a lot more flexibility when it comes to customer collections: when you've got money in the bank, you won't sweat it when someone pays late. When cash is tight, which is often the case for new and small businesses, you may not be able to carry customer credit balances, and that makes offering credit a less good idea. This is particularly true when you are selling products that you have to buy (and pay for) in advance; shelling out cash, and then struggling to collect from customers, can quickly put you out of business.