Information on Businesses
Credit information is generally easier to obtain for
businesses than for individuals because businesses often have
more publicly available information than do individuals.
The amount of information you collect should be in proportion
to the amount of credit you intend to extend. If the credit
limit you're offering is relatively low (say, $500), and the
company has a good credit reputation as far as you know, you may
not want to spend your time gathering more credit information.
If, on the other hand, you intend to offer a high credit limit
to a company that you don't know well, you may want to collect
as much information as possible.
Financial statements. Financial statements are a
valuable source of information. They'll tell you about the
company's cash flow and about the income it's generating. You
should ask for the current
balance sheet, the current
income statement, and previous years' financial
statements. You don't have to be an experienced accountant
to get useful information out of them. Here are some tips for
using these documents:
The balance sheet is probably the most useful of the
documents. It will show you both the cash the company has on
hand and the amount of money it owes to other businesses. That
will give you a general idea of its present ability to pay its
Another way to gauge a business's creditworthiness is to
compare two sets of numbers.
The first set of numbers to compare is the ratio of the
company's current assets to its current liabilities. This is
called the current
ratio. If the current liabilities are greater than the
current assets (in other words, the ratio is less than 1:1), the
company is probably not a good credit risk. Anything over 2:1
(in other words, the current assets are at least twice as much
as the current liabilities) is a sign that the company is
probably a good risk. Anything between 2:1 and 1:1 is an iffier
proposition, and you should probably seek more information.
The second set of numbers to compare is the company's total
equity to its total debt. This is the debt-to-equity
ratio. If the total debt is more than the total equity (in
other words, the ratio is less than 1:1), you should be careful.
This is especially true for smaller companies. It is not
uncommon, however, for larger companies to carry more debt than
they have equity.
Income statements and the previous years' financial
statements are generally not as helpful as balance sheets. But
if you can get your hands on statements for the past three or
four years, you should be able to get some feel for how the
company has been doing by comparing the numbers. If income is on
the rise during those years, the company is growing and it may
be a good credit risk. If not, perhaps you should be hesitant to
extend it credit.
Credit references. Businesses can also give you credit
references. But let's realize up front that credit references
are, for the most part, worthless. If you ask for a reference,
which names and numbers will a potential creditor give you?
It'll give you only those references who will say good things.
The only value to these references, then, is if you call a
credit reference and they give you negative information about
the business (or say they never heard of it). In that case, you know
that the company's credit isn't any good, if their best
references have bad things to say about them.
A possible alternative is to find out on your own who else
they do business with, and ask those companies about them. If
you have salespeople, they are often a good source of
information about who else the company does business with.
If you get a call for a credit reference on
someone else, be careful what you say. Don't
give any opinions. Tell them only the
amount the customer owes you, the current amount
due, and the amount that is 30 days, 60 days, or
90 days past due. In short, give them only what
they could get if they saw a statement you sent
to the customer.