Over the past year, you’ve been courting and cultivating potential new clients. After submitting a handful of proposals, at last a call comes in from a property management firm in need of a new sewer and drain contractor. But, a little due diligence reveals that the new potential client seems to be more risk than the company is willing to stomach.

While one could argue that the credit inquiry should be done ahead of prospecting efforts, this scenario plays out with unfortunate frequency.

“Measuring credit risk and determining who to extend credit to and how much is an art form, not a science,” says Karl Silverberg, a New York construction law attorney who regularly handles credit and collections matters. “You want to start out running a Dun & Bradstreet or Experian report on the company, but unless it’s abysmal, it’s not smart business to solely rely on it.”

Credit experts generally agree that there’s an array of considerations to digest when looking at a new customer. “Credit reports and financial statements are essential to review, but there are business decisions that need to be addressed that go beyond credit reports and financial statements,” says Hanna Lee Blake, a Washington, D.C.-area construction law attorney with Watt, Tieder, Hoffar & Fitzgerald. “You want to know if they have a blemish, is it one single project that went south or is it a historical pattern. If they’re a big potential customer, you want to assess your risk. Are you willing to wait 60- to 90-plus days for payments? Are you sufficiently financially sound to take that on? And what’s your recourse should an issue arise with getting payments released?”

Many in the industry recommend starting with a small line of credit if possible and putting the onus on the customer to build upon it. “If you’re on the fence whether to take on a new contract, you should be devoting some time to reading the terms and conditions of the agreement very carefully,” Blake says. “You want to do everything possible to ensure you retain your lien rights.” She also advises clients not to fear redlining a contract and eliminating unfavorable terms.   

The size of an organization and financial health are extremely important when evaluating appetite for risk. A small sewage and drain cleaning contractor can be detrimentally impacted by one bad credit decision, whereas a larger organization with deep pockets can more easily weather an extremely slow payer or, worse, a customer who runs into financial issues and is unable to pay. In many instances, small customers present a higher risk than large organizations, though many small ones tend to operate more conservatively or within a specific niche to reduce their potential exposure.

While maintaining reasonable flexibility in making credit determinations is advisable, so too is having a framework to operate within, and this is where establishing a corporate credit manual can be very valuable.

There are a number of advantages or valid reasons for investing the time and effort to develop a written credit policy, according to Bharpur Singh, a longtime credit consultant and owner of the Syracuse, New York-based consulting firm T. Gschwender & Associates. Here are some of the more important reasons he highlights:

A written policy is one way to ensure continuity in the event that key credit/finance personnel leave the company.

A written policy establishes a basis for consistency.

The policy provides a reference tool so key questions or considerations are not overlooked.

It can be used as a training tool.

It can be used to help evaluate or benchmark job performance against established standards documented in the policies and procedures manual.

Singh emphasizes the importance of keeping a credit manual that’s relevant to the way the company actually operates. “Businesses often make the mistake of simply downloading a credit manual online or having a general practitioner attorney draft the policies. But every company is a unique entity, and what works for you may not work for me.”

Another mistake Singh points out is for a business to draft a credit manual and then leave it untouched for years. “Business environments change over time,” he says, “and appetite for risk can change as well. In the wake of the 2007-08 financial crisis, many organizations across numerous industries were forced to tighten things up, and that came on rather quickly. But for most, it would be an inhibitive mistake to say the policies imposed back then should be untouched today.”

When payment issues arise, it’s generally advisable to avoid collections agencies and to try and handle things internally. In certain situations, extending payment terms to an outstanding receivable account is often a more effective and less expensive option than sending the account to outside collections. This is called “soft collections.”

“It’s not uncommon for customers to want to pay their bill but lack the resources to make a single large payment,” Silverberg says. “Affordable monthly payments are an attractive option for these customers. If sent to outside collections, the agency generally suggests a payment plan as a first option in the collections process. For this, the business pays a 25 to 35 percent collections fee on what is collected. If the business extends its own payment terms, it saves the collections fee while still receiving payments.”

For example, assume 10 accounts each with $3,000 balances due were sent to an outside collections agency. At best, the company would net between $19,500 and $22,500 of the total $30,000 outstanding. Adding to the cost, collections agencies typically only collect on 40 percent of the accounts worked, which further reduces the business’ net to $7,800 to $9,000 of the $30,000 outstanding. This translates into $0.26 to $0.30 cents on the dollar being paid to the business.

There’s also a general consensus that pure collections firms don’t typically take the time to understand individual situations or businesses. “It’s best to establish a relationship with a good credit and collections attorney,” Silverberg says. “They will know you on a first-name basis, will understand your business and your clients. Every collections matter is unique, and a general collections firm won’t typically take that into account.”