Factors Influencing the Decision to Extend Credit


There are important factors a company may need to consider before extending credit to another business.

The credit controller should assess the financial stability and creditworthiness of the business before extending credit. This includes evaluating their financial statements, credit history, and payment history. Having done this it’s necessary to determine a credit limit for the business, and ensure that the credit extended does not exceed this limit.

In terms of short-term financing the credit controller should review the business's current debts and whether they are manageable or may pose a risk to its ability to pay its debts. The credit controller should consider the availability and value of collateral that can be used to secure the credit extended. The company should establish clear payment terms, including the due date and any penalties for late payments. For larger exposures it may be worth considering whether credit insurance is necessary to protect the company from potential losses due to non-payment.

The relationship with the business is a factor too, considering the company's relationship with the business, including the length of time they have been doing business together and their past performance in terms of paying their debts.

The credit risk assessment can look at the industry risk associated with the business. Some industries are more susceptible to economic downturns and may pose a higher risk for non-payment. The credit controller should consider whether the business's sales and revenue are affected by seasonality and how this may affect its ability to pay its debts.

The size of the business is important, as larger businesses may have more resources to pay their debts. The credit manager should also check the legal status of the business to ensure that it is in good standing and that there are no outstanding legal issues that could affect its ability to pay its debts. If the subject company is smaller or owner-run, the credit controller may wish to consider whether a personal guarantee is required from the business owner or other key individuals to ensure that they are personally liable for the credit extended.

Background information should include the type of business they are dealing with (Retail, Wholesale, Service etc) and being aware of payment patterns, expectations and influences in that sector. Sales and revenue is key and credit assessment must consider the business's current and projected sales and revenue, as well as its ability to generate cash flow. Sales data may not be available for smaller entities, and in these cases indicators must be drawn from the balance sheet.

The location of the business and the local economy may be a factor in determining whether it is in a high-risk area for non-payment, this may be more significant for smaller local businesses relying on their local economy.

The credit control process should consider the ownership structure of the business, as well as the qualifications and experience of the owners and management team. A holding company may also be investigated to ascertain the financial status of the group.

Wider influences for consideration include the level of competition in the business's industry and how it may affect its ability to generate revenue and pay its debts. Also, the current and projected economic conditions, including interest rates, inflation, and unemployment rates. Beyond that are the market conditions, i.e., the current and projected market conditions, including supply and demand, prices, and trends.

Not all information will be accessible, and some may only be disclosed for major business partnerships with in depth due diligence. This level of investigation could include business plans and strategies for growth and sustainability. There may be additional data about partnerships, joint ventures, and other strategic alliances and how they may affect its ability to generate revenue and pay its debts. As well as senior management, the credit control process may consider the qualifications, experience, and stability of the business's other key management and staff.

Finally, reputation should not be underestimated, this means the business's reputation, including its standing in the community and its past performance in terms of paying its debts.

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