When your company extends credit to customers for goods or services, your company is acting as a lender. No reputable bank extends a loan without first establishing the creditworthiness of the customer and neither should vendors.
Similar to a bank, vendors should gather data from a new customer, use these data to decide how much credit to extend, and extend a specific amount of credit based upon mutually agreed to terms of payment.
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Typically, vendors use the credit application to gather information and establish the terms of the vendor-customer contract. The Credit Research Foundation published a survey of nearly 100 credit managers to find out how frequently different topics were covered on a credit ap. A credit application should be used to:
- Collect data and receive permission from the customer to evaluate creditworthiness;
- Detail the vendor’s terms of extending credit to the customer;
- Explain terms that protect the vendor if the customer becomes delinquent;
- Explain additional terms governing the vendor-customer relationship;
- Include a signature block that is legally binding.
Credit Application – Things to Consider
When a vendor/customer relationship is complicated and/or involves very large purchases, there should be a lengthy contract which defines important terms for both parties. The credit application is not the correct place to include a lengthy contract.
Oftentimes, however, the credit application is the only legal document between the vendor and the customer that includes the customer’s signature. As such, the credit application provides an opportunity for the vendor to establish important terms and protections relating to the ongoing vendor/customer relationship. When a business relationship begins, vendors have power because they have something that the customer wants: goods or services to be provided now but paid for in the future. Before the first sale is when the vendor has the chance to require the customer agree to industry standard terms. Once the first sale is made and the product delivered, the customer may be less inclined to agree to any new terms.
The good news is that customers understand this, and key terms can easily be included in the credit application verbiage. Care must be taken, however, to not include too much and turn off the potential customer causing them to take their business elsewhere. Generally speaking, customers will not appreciate excessively long complicated forms. Vendors must carefully create their credit application with an eye to getting the terms they really need while keeping the form simple and straightforward. Credit applications should be one page long if only gathering information and two pages if terms of granting credit are included. Credit applications are occasionally longer, but as a general rule, two pages should be sufficient to collect data and lay out the terms that will protect the vendor.
Information Needed to Evaluate Credit
To evaluate credit, request this information:
- Name of the Company;
- Mailing address of the Company;
- Entity type (Corporation, LLC, or proprietorship);
- Owner’s name;
- Name of person who will be placing orders;
- Accounts payable contact name;
- Contact information (phone number, cell phone number, email addresses);
- How customer plans to place orders (email, fax, phone, purchase order);
- The dollar amount of credit customer requests;
- References (vendors they already work with and bank).
With this information in hand, the next step is to spend some time checking the validity of the information to determine whether or not the potential customer is creditworthy. At the very least, run a business credit report.
Contract Terms to Include in Credit Application
The credit application works as a contract so be sure to include the following terms:
- The credit application is a binding agreement;
- The signatory is authorized to bind the company to the terms;
- All information included is true and accurate;
- Permission is granted to the vendor to check the applicant’s credit;
- The vendor has sole discretion to grant credit to the applicant;
- The customer is legally bound to pay for all purchases provided on credit;
- The vendor’s forms have precedence over the customer’s forms (e.g., purchase orders).
Including these terms in the credit application ensures that the applicant knows they are signing a contract and gives the vendor permission to determine creditworthiness, grant credit and respond to any problems based on the terms included in the signed credit application.
Terms to Include in Case of Default
Add the following terms to the credit application to protect against nonpayment:
- Personal Guaranty if the customer goes delinquent;
- Interest charge if payments are late and acceleration of all invoices as soon as one is past due;
- Customer will be responsible for collection and/or attorney fees if applicable;
- Disputes will be litigated (my recommendation) or arbitrated (costs more);
- The state where lawsuits must be filed;
- Waiver of right to a jury.
When a customer is late making payments, including these default terms in your credit application can give you a significant advantage during the debt collection process. These terms give you better leverage as compared to other vendors who are also not getting paid and are chasing the same customer. They also enable you to recover the costs of collection and litigation which are not otherwise legally allowed.
Optimally Designed Signature Block
A properly designed signature block is extremely important. The signatory must include his/her title so that the vendor can determine whether or not he/she has the authority to sign on behalf of the company. Include a separate signature line for a personal guaranty and do NOT include the person’s title at the company. This is because the signatory is signing as an individual, not as an officer. If the customer is located in a community property state, the personal guaranty must also be signed by the spouse of the personal guarantor.
19 Credit Application Samples
An excellent resource to use when developing a credit application is a free downloadable ebook called the Credit Application Handbook. The ebook contains 19 credit application samples, including sample wording, explanations and downloadable word versions of each sample that can be easily customized and branded for your business.
The best way to minimize bad debt is to establish favorable payment terms upfront, properly determine a customer’s creditworthiness before extending credit, and take appropriate action as soon as a customer goes delinquent. The Commercial Law League of America statistics reveal that once an invoice is past due, the chance of collecting declines more than 1% per week. After 90 days, the chance of collection has already declined by 26% and it gets worse as time passes. Protect your company with a good credit application.
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