Chapter 8 Receivables 369Screening Customers
Screening customers involves assessing which customers should be granted credit. Too
strict a credit-screening process causes the company to lose revenues and profits from
customers who would otherwise pay their accounts on time. Too loose a credit-screening
process causes the company to extend credit to cus-
tomers who do not pay. Not only does the company
lose any profits on nonpaying customers, but the
company also incurs the expense of providing the
goods or services to the customers as well as the
additional expense of trying to collect the amounts
due. For this reason, too loose a credit-screening
process can be more costly than too tight a policy.
Most businesses have formal credit-screening
procedures that include customer-submitted docu-
mentation of creditworthiness. For example, if you
apply for a credit card, you have to fill out an appli-
cation form. Likewise, if you apply for a student loan
or home mortgage, you have to fill out a loan appli-
cation form. In addition, loan applications normally
require the customer to also submit other documents,
such as recent tax returns or bank statements.
Business customers that apply for credit often are asked to submit recent financial
statements with their credit applications. Sometimes the seller will also require a letter
of credit from the business’s bank. The letter of credit documents that the business has
funds available to pay the seller. Letters of credit are often required when a buyer is
purchasing goods from overseas sellers. In rare cases, a seller may also require the cus-
tomer’s bank to guarantee the credit of the buyer.
Once the seller receives the buyer’s credit application and documents, the seller
analyzes the buyer’s creditworthiness. In addition to analyzing the application and
documents submitted by the buyer, the seller usually requests an independent credit
report and often will contact the buyer’s banking and other credit references. The Dun&
Bradstreet Reference Book of American Businessprovides credit ratings for many business
customers. The amount of analysis for a customer will, of course, vary with the size of
the buyer’s purchases. For example, credit card applications with credit limits of $1,500
do not receive as much analysis and independent verification as a business’s credit
application for a $500,000 purchase.Determining Credit Terms
Once a seller has decided to grant credit to a buyer, the seller must determine credit
terms for the sale. Credit terms include determining the amount of credit, called the
credit limit, and the payment terms. The credit limit is set consistent with the credit-
worthiness of the customer. New customers often receive a small limit that is increased
over time as the customer pays accounts and thus establishes a good credit history
with the seller.
The payment terms are often set so that they are consistent with the seller’s in-
dustry and competitors. For example, MasterCardandVISA’s payment terms require
full or partial payment within 30 days. Any amounts due after 30 days are subject to
interest charges. Likewise, businesses often set payment terms of 2/10, n/30. As we
discussed in Chapter 5, these terms offer the buyer a 2% discount if the invoice is paid
within 10 days, with the entire amount due within 30 days. Regardless of the payment
terms, the seller should communicate them to the buyer at the time of sale. In most
cases, the payment terms are stated on the sales invoice.© 2005 EXPERIAN