For business owners, extending credit to customers can be a double-edged sword.

While offering credit terms may encourage new business and larger orders, it also opens the door to risks like overdue payments, bad debts, and even financial instability. That’s where credit checks come into play.

Credit checks are a vital tool for businesses, helping assess a customer’s financial health before extending credit.

By understanding credit reports, credit scores, and repayment history, businesses can make informed decisions, minimise bad debts, and protect their cash flow. And in this article, we’re going to give you some insight into how using credit checks effectively can help to reduce risks and strengthen your bottom line.

Why credit checks are essential for minimising bad debts

Bad debts can quickly derail a business’s cash flow, leading to lost revenue and strained supplier relationships. But there are some things you can do to avoid them, including conducting credit checks. Doing this allows business owners to evaluate a customer’s credit health and repayment history, making it easier to identify potential risks before they arise.

Here’s why credit checks are so important:

• Identify high-risk customers: Spot warning signs like overdue debts, outstanding payments, or a poor credit score.
• Protect cash flow: Ensure that customers are likely to pay on time, helping maintain financial health.
• Set appropriate credit limits: Credit checks allow businesses to establish limits that align with a customer’s ability to pay.

What information do credit checks provide?

A credit check, obtained from credit reporting agencies or bodies, offers a snapshot of a customer’s financial behaviour. The key details include:

• Credit score: A numerical representation of creditworthiness, calculated based on repayment history, outstanding debts, and payment patterns.
• Credit report: A detailed record of a person or company’s credit activity, including overdue payments and defaults.
• Repayment history: Insights into whether a customer pays their bills by the due date or struggles with late payments.

In Australia, businesses can access credit reports from credit reporting agencies and these reports often include additional data, such as credit applications and financial stability indicators, to help businesses decide whether to extend credit.

When should you perform credit checks?

Timing is everything when it comes to credit checks. To minimise bad debts, businesses should conduct checks:

• For new credit applications:
  Before approving a customer’s request for credit terms.
• When customers request larger credit limits:
  Ensure they have the financial capacity to handle the increased responsibility.
• Periodically for existing customers:
  Credit health can change over time, and regular checks help maintain confidence in ongoing relationships.

Red flags to watch out for in credit reports

Credit reports provide valuable insights, but it’s essential to know what to look for. Red flags that may indicate a high risk of bad debts include:

• Overdue payments:
  A history of late payments or unpaid invoices suggests potential challenges in meeting future payment terms.
• Outstanding debt:
  A high amount of existing debt relative to income or credit limits.
• Frequent credit applications:
  Multiple recent applications for loans or credit may signal financial instability.

It’s also important to keep in mind that there can be various reasons as to why any of the above has occurred, so while they can be indicators of potentially undesirable customers, they should not be the sole basis for your decision. Use your discretion when evaluating these factors and ensure your payment terms or credit applications collect sufficient information to allow you to make an informed judgment. This balanced approach will help you assess potential risks while considering the unique circumstances of each applicant.

Ways you can use credit checks in your business

Credit checks are a powerful tool for managing risk and ensuring your business maintains healthy cash flow. By integrating them into your processes, you can make informed decisions, build stronger customer relationships, and protect your business from potential financial setbacks. Here are some practical ways to make the most of credit checks:

1. Establish clear credit policies. Developing a well-defined credit policy is essential for consistency and transparency. Outline the process for reviewing credit applications, including when credit checks will be conducted and the criteria for approval. Communicate these policies clearly to your customers during onboarding to set expectations from the start.
2. Partner with reputable credit reporting agencies. Collaborating with trusted credit reporting agencies gives you access to accurate and up-to-date financial information. You will usually also have access to additional tools and resources, such as automated reporting and alerts, to simplify the credit-checking process, saving you time while ensuring reliability.
3. Set credit terms that align with repayment capacity. Use the insights from credit reports to tailor credit limits and payment terms to each customer’s financial situation. This approach reduces the likelihood of overdue debts while ensuring your business maintains a healthy cash flow. But it may mean more administrative work on your end to manage.
4. Monitor and reassess credit regularly. Customer circumstances can change, and financial stability today doesn’t guarantee it in the future. Schedule regular reviews of credit reports to identify any emerging risks and adjust terms proactively. This practice allows you to stay ahead of potential issues and maintain sustainable customer relationships.

By integrating these practices into your operations, you can minimise risks, make more informed decisions, and foster a smoother credit management process for your business.

Alternatives to credit checks for reducing risks

While credit checks are a powerful tool, they’re not the only way to mitigate risks and manage payments effectively. Consider these complementary strategies:

• Request upfront payments:
  For high-risk clients or large orders, partial or full upfront payment can safeguard cash flow.
• Shorten payment terms:
  Reducing the time frame for payment minimises exposure to bad debts.
• Invest in accounting software:
  Use platforms that track invoices and payment due dates to streamline your debt recovery process.

As a business owner, you can empower yourself and ensure that you reduce your risks of accumulating bad debt.

The role of debt collection in managing bad debts

Even with the best credit check practices, bad debts can still occur. That’s where debt recovery services come in. By partnering with a professional debt collection agency, businesses can recover overdue payments without straining client relationships.

JMA Credit Control offers businesses an effective solution for managing outstanding debt. With a personal touch and expertise in Australia’s financial landscape, JMA helps businesses minimise losses and maintain strong cash flow.