Is giving direct credits to customers a worthy risk for small businesses?
Goods and services can be paid for upfront or on delivery or supplied on credit. Credit is where payment is deferred for a given period after the supply of goods or services. Before extending a direct line of credit to customers, a business needs to decide whether this is a risk worth taking.
Pros and Cons of offering Direct Credit
Offering credit to your customers can be a risky but rewarding endeavor (03).
Pros of offering Direct Credit
- An increase in sales as offering credit will attract more prospects and close more deals.
- Enable you to establish trust with customers
- It increases customer loyalty, goodwill and builds good customer relations.
- It makes customers less sensitive to price and more focused on the products and services you offer.
- Shows stability and enhances the business reputation
- It gives you a competitive edge as not all businesses offer credit.
Cons of offering Direct Credit
- One of the major disadvantages of offering credit is the potential for loss when customers fail to pay (03).
- Its effect on the cash flow
Tips to ensure Customers Pay Direct Credit
If you provide credit to customers, it is advisable to set proactive policies and procedures to cut down on the number of delinquent accounts receivable. Other tips to ensure customers pay you on time include:
- Doing credit checks before extending credit
- Taking partial payment in advance
- Invoicing promptly
- Stating the payment terms and conditions clearly
- Incentivize the customer behaviour you want (Jimenez, 2019) by offering discounts and other rewards for early payment
- Establish a follow-up procedure to ensure you quickly follow up on a missed payment
- Turnover any overdue account to a collection agency
- Leverage technology by automating the entire process.
Journal Entries for Account Receivables
Account receivables are the money customers owe you for goods and services bought on credit.
- When a sale is made, credit the sales account and debit the accounts receivables account.
- When payment is made cash debit the cash account and credit the accounts receivable
In case a customer fails to pay, the business encounters some losses called bad debts (Singh, 2020). Bad debts are recorded in two ways, i.e. direct write-off and the allowance method. Example of direct write-off journal entries:
Article Sources that you can check out to learn more about Direct Credit to Customers
- Credit, Extending Definition – Entrepreneur Small Business Encyclopedia. (n.d.). Entrepreneur. (URL)
- Jimenez, R. (2019, June 11). What to Do When Customers Don’t Pay: A Guide to Accounts Receivable. PaySimple Blog. (URL)
- Kappel, M. (2016, September 13). Offer Credit to Customers | The Pros & Cons of Extending Credit. Patriot Software. (URL)
- Singh, J. (2020, November 19). Accounts Receivable Journal Entry. WallStreetMojo. (URL)
- Ward, S. (2019, June 25). 7 Ways to Make Sure You’re Getting Paid by Customers and Clients. The Balance Small Business. (URL)
- The Top Strategies for Improving Your Credit Score
- The Purpose of an Income Statement for a Retail Business
- Pro forma Financial Statements
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