How to Check the Creditworthiness of a Prospective Customer
Who doesn’t love the prospect of a new customer? But are all prospects created equal?
Choosing the right customers for your business is essential, and a small investment in determining the creditworthiness of your prospective customer at the outset could save you a small fortune later down the line.
What makes a good customer?
We often seek to answer this question from a sales and marketing perspective.
- Are they in our target market or match our customer persona?
- Is their timeframe/budget flexible and realistic?
- Are they focused on outcomes, not features?
- Does the client align with our Purpose, Vision, and Values?
These are all excellent selection criteria, but there should be two more:
- Do they have the means to pay?
- Are they good payers, i.e., do they pay to terms?
Now you might think that paying on time should be a given if they have the means to pay; sadly, in many cases, it isn’t.
Customers with poor administration, lengthy payment processes or even a deliberate policy of ‘don’t pay until you get the final demand’ can all have a devastating effect on your cash flow.
So, how and where can you find out which type of customer they are likely to be?
Do a Credit Check
Whilst you can run credit checks on individuals, I’m primarily talking about credit checks on businesses.
This is a paid-for service offered by Credit Reference Agencies. An agency collates data available from several public sources (e.g., Companies House, CCJ register, etc.) and from data supplied by some of their clients (debtors ledger data) to create a predictive scoring model and generate a credit score for every business.
The higher the score, the better. Within that score will also be an assessment of how the business pays its suppliers. Again, the higher the score, the more likely they will pay you on time.
Note: you don’t need consent to run a credit report, and we can do it for you. Get in touch to order your report.
Check the Financial Data (Companies House)
You can do your own assessment of the last set of accounts filed at Companies House for incorporated businesses. For sole traders and partnerships, you may have to ask your prospect to share their latest profit & loss account or balance sheet with you to do this for them.
A word of caution. These accounts are already out of date by the time they are filed, so your prospect’s creditworthiness may already have changed.
The time usually allowed for delivering accounts to Companies House is:
- Nine months from the accounting reference date, for a private company
- Six months from the accounting reference date, for a public company
Also, note that what should be filed at Companies House depends on the size of the business, so data may be limited for micro and small businesses.
A micro-entity meets two of the following conditions:
- turnover must be not more than £632,000
- the balance sheet total must be not more than £316,000
- the average number of employees must be not more than 10
What classes as a small business may surprise you. A small company meets at least 2 of the following conditions:
- annual turnover must be not more than £10.2 million
- the balance sheet total must be not more than £5.1 million
- the average number of employees must be not more than 50
Micro and small businesses do not have to submit a copy of their profit and loss account to Companies House.
The Prospective Customer
You will not have got this far without having had a conversation with your prospective customer, and we covered some of the information to gather in our blog: Protect your Cash Flow with Customer Information.
If the customer is a well-established business, you could ask why they are coming to you for supplies, especially if you know they’ve been using a competitor. Switching suppliers could be a tactical move to get a better price or better quality, but it could also be that they have maxed out their credit line with their existing supplier and have been put on stop!
You can also ask your prospective customer to provide the latest copy of their management accounts if the financial data publicly available does not look favourable or they are a new business that has yet to file any accounts.
Any pushback on this could raise a red flag, particularly if they insist on having a credit account.
Mainstream & Industry Specific News Outlets
Has the customer been in the news lately? If so, was it favourable or unfavourable publicity? Use the information in the articles to start a conversation with the customer.
For example, if an article says they’ve been making redundancies, you can establish if this impacts their creditworthiness or cash flow by asking why the redundancies were necessary and about the business’s goals.
Again, look for what the business is talking about and what the directors and employees are talking about. Are there any red flags that could indicate a change in their creditworthiness? Anything that should prompt a conversation?
Trade References and Your Network
I’m not a fan of trade references supplied by the customer as these can be cultivated. By that, I mean that the business picks a couple of suppliers they deliberately always pay on time and uses these as trade references. Hence, they always get a favourable reference. They can be useful for knowing the types of customers they have.
Use your network to gather more intelligence about what they are like to work with. If no one in your network has worked with your prospective customer, reach out a little further and get an introduction to someone who has and have a conversation with them.
You don’t have to offer credit terms right away.
You could take your time and get to know your new customer a bit before offering them credit terms by asking for payment on the presentation of the invoice, either in advance or on the day delivery of the goods or services is completed.
This can help you build trust and gain evidence to support whether your customer is financially strong enough and has the right attitude to pay if granted credit terms.
A useful tool for working with start-ups where creditworthiness is hard to determine because of minimal financial and payment history on which to base a decision.
Whilst good creditworthiness is a wonderful thing; you need to ask yourself, “do I want you as a customer?”.
Payment on time will not compensate for a relationship that doesn’t quite gel, is highly demanding on your time and causes you and your team stress.