Extending credit to clients can help grow your business, but it also comes with risks. Before offering payment terms, you should evaluate whether a client can meet their financial obligations.
Proper credit assessments reduce the chances of unpaid invoices and collection issues.
Review financial statements and credit reports
A client’s financial health is a strong indicator of their ability to pay. Although not always practical, if possible, request financial statements such as a balance sheet and income statement. Reviewing these documents helps identify red flags such as excessive debt or declining revenue.
Additionally, obtain a business credit report from agencies such as Dun & Bradstreet or Experian. These reports provide scores based on payment history, outstanding debts and legal filings, which can help predict future payment behavior.
Investigate payment history and trade references
A client’s past behavior often indicates future reliability. Ask for trade references from suppliers or service providers the client has worked with. Contact these references to learn if the client pays on time or if payments are delayed. Public records, such as Uniform Commercial Code (UCC) filings in California, can also reveal existing liens or secured debts that might impact a client’s ability to pay your invoices.
Verify business licenses and legal standing
Ensure the client is legally registered and in good standing. In California, you can check a company’s status through the California Secretary of State’s business search portal. A business in bad standing might face legal or financial difficulties, increasing the risk of default. Additionally, review any pending lawsuits or judgments against the company, as these can indicate financial instability.
Use contracts with clear payment terms
Even after assessing creditworthiness, it’s essential to protect your business with well-drafted contracts. Define clear payment terms, including due dates, late fees, an attorney fee clause and dispute resolution procedures. Also, if you are a California-based business, your agreement should generally provide that California law controls and that any disputes will be heard by a trier of fact located in California. Enforcing structured contracts minimizes disputes and strengthens your position if collections become necessary.
Taking these steps ensures your business works with clients who can meet their financial obligations, reducing the likelihood of unpaid commercial debts.