The Positives and Negatives of Extending Credit

While it won’t be relevant to every business, customer credit is an established method that some companies have successful used to generate increased revenue.  By extending credit to their customers, some businesses will allow them to defer payment for a period of time – essentially loaning them the product in exchange for the promise of money later.  Sound risky?  It definitely can be.  That’s why it’s important that you know the ups and downs of extending credit before you decide to add it to your business model.         

Competitive advantage

Credit allows you to provide your goods or services to individuals who otherwise may not be able to afford it.  This not only expands your market, but also allows you to differentiate yourself from the competition.  These new customers are also likely to be more loyal, as you are one of a small number of companies who will accommodate their budget.

Get customers to spend more and build goodwill

Goods we want to purchase are often out of reach.  We may want that shiny new TV or couch, but we can’t afford it right this moment.  By offering credit on big ticket items, more customers will be willing to shell out for a luxury item.

Allowing your customers to defer payment is also a demonstration of trust on the part of the organization.  As a result, your consumers will feel more valued and be more likely to return for other purchases down the line.

Unsecured loans are inherently risky

The most obvious downside is that deferred payments will naturally make paying the bills a much more complicated process.  You might defer payments on a new desk until January, but what happens when you need money now?  The unpredictability of a sales model based on unsecured loans is one that many business owners may be poorly equipped to deal with.  Even if you schedule sales to cover your monthly expenses in a timely manner, a single customer not paying on time can throw the whole system into disarray.  The business will be missing a significant amount of revenue that it desperately needs to keep the company running, and likewise, the customer will be charged a significant amount of interest, which they may be unable to pay.  As such, it is crucial that owners are careful about who they extend credit to, and that they don’t offer more credit than what they can afford in case they are not paid.  They must also ensure that they have sufficient cash flow to sustain their business during dry periods.

For many businesses, it is important to note that any missed payments will cause consumers to accumulate interest on the entire amount that the item is worth.  You must be clear about what your interest rates and late payment policies are if you want to avoid alienating your customers.  This makes evaluating your customers’ credit rating a pivotal part of the sales process, but this also requires additional time and money.

Once again, bear in mind that not every business can or should offer credit.  But if your company specializes in big ticket items, then it can potentially be a boon to your sales.  Weigh the pros and cons carefully, and decide if it is right for you before you take the plunge.

Lance | DBPC Blog