In our last
blog, we talked about three out of the five Cs of credit: character,
collateral, and capacity. Now we’ll discuss the final two Cs: capital and
conditions.
Examining
Capital
A company’s
net worth is made up of capital that has been paid into it over the years,
along with any that has been generated through profitable operations (“retained
earnings”). Ideally, you can compare two or three financial statements next to
each other to spot trends in net worth. You’re looking for your customer’s net
worth to increase each year, meaning that capital is being put into the
company—that the company is profitable and is keeping some of its earnings
rather than paying them all out of shareholder as salary or dividends, or both.
Reacting
to Conditions
An excellent
practice to follow when extending credit is to consider the general conditions
of your industry, as well as overall economic conditions. Although good
customers may pay their bills timely even in poor economic conditions, when
industry or general economic conditions take a downward turn you must monitor
payment trends for even your best, most reliable customers.
When
conditions are good, customers have lots of money and customer demand. Orders
are high, and you’re willing to take some additional risk to maximize your
profits, so more goods are shipped out on credit terms.
In difficult economic conditions, competition from other companies in your market affects how much risk you’re willing to take. If your goods or services are scarce or unique, you can more easily impose credit terms that better protect your business. The less unique your product, the more you must deal with market pressures that may force you to extend more credit than you’re really comfortable with.
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