Extending credit to customers is an intelligent business process that can be immeasurably valuable in gaining customer loyalty. However, if not done both carefully and thoughtfully, it can become one of the most damaging practices in business. Previously, we worked through the process of wisely determining credit extensions. As discussed, when defining this limit, small businesses often times pull credit reports from agencies such as Dun & Bradstreet, Experian, and Equifax. The problem is that these reports are very expensive. A basic report typically includes court filings (such as bankruptcies, liens, judgments, and UCC filings). Fancier reports include credit scores and financial stress scores that attempt to give an “accurate” picture of a business’ probability of re-paying its vendors. For example, Dun & Bradstreet has established a “Paydex” score (similar to the FICO score for consumers, but in this case, for businesses). The Paydex score measures how well a business pays its vendors, and it is on a scale of 0-100, with 80 signifying a customer that pays promptly. The below chart explains the Paydex scale:
Credit bureaus charge a lot of money for these credit reports:
- To conduct a simple bankruptcy – tax lien – judgment search on a business using Experian’s database, it costs $10/search. For a report that includes a full credit score and financial stress analysis, you have to pay $99/month for ONE report .
- With Equifax, a small business credit report costs you $99.95!
- Lastly, Dun & Bradstreet’s cheapest report (that only includes court filings and NO credit scores) costs $25/report.
What is really frightening is to put these numbers into perspective. Imagine the amount that can be spent on credit reports in one year. Using Dun & Bradstreet as an example, if a company has 1,000 customers and wanted to screen and monitor all of them, at $25 for the cheapest, most bare-boned report, that is $25,000 a year! $25,000, the equivalent of a brand-new car, or even the price to bring on a new employee.
It’s sometimes hard to believe that small businesses are actually willing to pay these prices, because the reality is: payment performance data of small businesses is almost impossible to get. Less than 2% of businesses report their customer’s payment data to credit bureaus. These 2% typically represent the large Fortune 500 companies that get perks, benefits, and discounts if they report payments of thousands of customers to credit bureaus. Relationships with their customers are more distant.
Small businesses, however, usually carry accounts receivable (A/R) on known and local customers that they see in church every Sunday. Business owners have little desire to report poor paying customers to the credit bureaus; it’s bad for business and for cocktails at the club. Moreover, small businesses are even less likely to report their own financials to the bureaus. Why would they? It does not provide them with any benefits.
Often times credit bureaus “claim” that their credit score and financial stress algorithms paint a very accurate picture of a small business’ payment habits. But, to determine the financial health of, say, a particular pizza restaurant in Manhattan, do you think that dividing the total pizza sales in Manhattan by the total number of pizza restaurants in Manhattan, and using that number, gives an accurate picture?
So why are these reports so expensive? Well, the big credit bureaus have been around for hundreds of years. They have been acting like an oligopoly and what they sell is their “premium brand”. For example, to register with the federal government for contracts or grants, every business is required to get a DUNS number, which is an identifier issued by Dun & Bradstreet. If you don’t get a DUNS number, you can basically forget doing business with the government.
These expensive prices make small businesses hesitant to pull credit reports because they know if they pull a credit report on a customer, and there is nothing wrong, than they will have wasted anywhere from $25 to $100 PER REPORT. Small businesses have therefore been gathering information and data on their customer’s risk profile from other sources:
- They call their friends and other suppliers that have been doing business with the customer.
- Because hard payment data is so hard to get, other services have emerged that try to gather “soft” facts about a small business’ credit profile, such as Cortera. They have a community based scoring system, where businesses can “rate” other businesses (similar to Yelp, but for business credit).
- Some industries have developed their own credit scores, such as Seafax, which provides commercial business information for the food industry in North America.
At the end of the day, this is your business and you will always be the most informed source on your customers, but doing high quality, results-driven research will only make your decisions more precise.
It’s crucial for you to check the credit profiles of your customers when extending them credit. The information is not perfect, but you need to work with the information that is available. Nonetheless, make sure you fully understand the information at hand, the accuracy of it, and how much you’re paying for it.