Business.gov - The Official Business Link to the U.S. Government
Extending Credit to Your Customers
By extending credit to your customers, you give them the option to purchase products or services today and pay for them at a later date. When your business accepts credit card payments and personal checks or invoices customers, it is essentially extending credit on the assumption that customers have the funds to pay for the transaction.
Extending Credit
When you extend credit to customers through card payments, the credit card company manages the risk. When you extend credit through invoices or personal checks, you are responsible for verifying and accepting payments and managing the risks that come with them. Read more about accepting card payments and accepting checks on Business.gov.
Extending credit through invoices is common in some industries such as construction or manufacturing, but may not be practical for every business. To decide if extending credit is right for your business, understand the associated risks and rewards:
- The option of credit enables customers to focus less on prices, enhances customer relations, and has the potential to generate more sales.
- Extending credit costs money. When you sell something on credit, you will not have payment on hand and will need to temporarily recoup the cost from other areas of your operating capital. Learn more about the fundamentals of cash flow on Business.gov.
- If customers don’t pay, you could be in for a long settlement process that may not end in your favor.
- Ask yourself if you have a significant business need to extend credit. Extending credit could be the factor that keeps your business afloat if it makes it easier for your customers to buy from you. Nevertheless, if it isn’t necessary it may not be worth the extra time and paperwork.
Establish Credit Practices
Before you extend credit to customers, establish detailed policies and understand consumer protection laws.
- Determine to whom you will extend credit such as individual customers or other businesses. Run credit checks on all customers before you agree to extend credit.
- Develop clear, consistent payment guidelines. Your bills should indicate when payment is due, when it will be considered delinquent, and who to contact with questions. The Federal Trade Commission's guide on How to Write Readable Credit Forms has more information on making sure you've included all of the correct information.
- Determine how you will bill or invoice customers. Will you or your employees mail requests for payment yourselves, or will you hire another company to handle invoicing?
- Create a plan for collecting late or defaulted payments. Regardless of the type of application or documents you use for credit transactions, be sure to get all of your customer's information in writing. In return, provide them with a copy of your payment policy, which spells out how penalties will be applied to late payments and how you will handle unpaid bills. It's important to have this documentation in case a fraudulent or delinquent credit transaction occurs.
Comply with Consumer Credit Laws
If your business extends credit to customers, you should become aware of consumer credit laws. The Federal Trade Commission (FTC) enforces the nation’s consumer protection laws. These laws regulate how you advertise interest rates, how much time you have to respond to billing mistake claims, how aggressive you can be when attempting to collect a debt, and other aspects of extending credit and debt collections.
- The Credit Practices Rule prohibits businesses that extend credit from using contract provisions that are unfair to customers, including confessions of judgment, waivers of exemption, wage assignments, and security interests in household goods. This rule applies to consumer credit contracts offered by finance companies, retailers, and credit unions. The Rule also requires businesses to advise cosigners about their potential liability if the other person fails to pay, and in some cases prohibits the use of late charges.
- The Truth in Lending Act requires all businesses to make certain written disclosures concerning all finance charges and related aspects of credit transactions are relayed to consumers (including disclosing finance charges expressed as an annual percentage rate). Furthermore, interest charged on late payments may be subject to state usury laws limiting the amount of interest that can be charged. If the maximum amount of interest is exceeded, the debt may be forfeited and a penalty assessed. The Truth in Lending Act also establishes requirements for advertising credit transactions.
- Enacted as an amendment to the Truth in Lending Act, the Fair Credit Billing Act is a federal law designed to protect consumers from unfair billing practices and provide a means for addressing billing errors in open-end credit accounts. Consumer Credit Law: An Introduction to the Fair Credit Billing Act has more information on what's required when you extend credit to customers.
- The Fair Credit Reporting Act regulates the collection, dissemination and use of consumer credit information. If your business uses credit reports to extend credit to your customers you must ensure privacy of credit information.
-
The Fair Debt Collection Practices Act prohibits debt collectors from using abusive, unfair, or deceptive practices to collect payment from consumers. This includes collection agencies that you might hire. Before hiring a collection agency to pursue your debtors, make sure that the agency is licensed and bonded. Your state's collection agency administrator can provide information on licensing requirements. In addition, check with your state's consumer protection agency or regional FTC office to see if there have been any grievances filed against the agency.
- The Equal Credit Opportunity Act makes it unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction on the basis of race, color, religion, national origin, sex or marital status, or age (provided the applicant has the capacity to contract); because all or part of the applicant’s income derives from any public assistance program; or because the applicant has in good faith exercised any right protected by the Act.
Dealing with Collecting Debt or Bankrupt Customers
What happens when a customer refuses to pay their bill? When you've gone beyond adding late penalties and you still haven't seen any payment, check with your local consumer protection agency to understand your options and state laws. This information will help you decide if you should report these actions to the police, employ a collection agency, or attempt the settle the payment by other means. Depending on your local laws and the severity of the delinquent transactions, it may be cheaper to simply swallow the debt.
You may find yourself in a situation where a customer to whom you've extended credit declares bankruptcy. In this instance, the debtor then has the benefit of an automatic stay immediately upon filing a bankruptcy petition. This stay stops you from taking any further action of trying to collect the debt unless or until the bankruptcy court decides otherwise. The U.S. Court System provides a bankruptcy guide for creditors and debtors about how to proceed in these situations.
If a money judgment is awarded to you in court, further action may
still be needed to receive payment. Such action may include contacting
the defendant, or in worse cases, providing information about the
defendant to a law enforcement officer so that they can assist you in
collecting the debt.
The best way to solve these situations is by preventing them from happening through strict credit policies and by conducting appropriate evaluations of credit risks before extending any credit.
Mechanic's Liens
Mechanic's and materialmen's liens have specific regulations that apply to their industries in cases where credited customers fail to make their payments. Liens exist in most states to provide special collection rights to those who provide services or building materials used to improve real property. If the debt is not paid, the lien can be foreclosed and the property sold to pay the obligation. For more information on the specific laws that govern these debts, visit your state's Department of Consumer Affairs or Protection.
