How to Evaluate a New Customer Before Extending Terms

Quick Overview

To evaluate a new customer before extending terms, verify the business and review its credit reports, trade history, financial condition, and industry risks. Use your findings to set an appropriate credit limit and payment requirements, then monitor the account for changes that could increase your exposure.

Every time you agree to invoice a customer and wait for payment after work or goods are delivered, you’re extending credit to your customer. While this is common in most business-to-business (B2B) industries, not all your customers are creditworthy, let alone deserving of the same terms. It’s essential to evaluate new customers before extending terms to limit your risk. We’ll walk you through what to look for and what to do with your findings in this guide.

Why Evaluations Are Crucial to Effective Accounts Receivable Management

Performing new customer evaluations can be time-consuming, but it’s worthwhile because it reduces your risk and protects your business finances. Let’s take a quick look at the mechanisms behind this.

Running a Business Credit Evaluation Can Protect Your Cash Flow

Just 52 percent of B2B invoices are paid on time in the United States, per Atradius. Performing evaluations before extending credit lets you see who’s likely to pay on time, so you can predict cash flow with greater accuracy and plan your spending or funding needs accordingly.

Credit Checks for Business Clients Reduce Bad Debt Risk

Five percent of B2B invoices are written off as bad debt, Atradius reports. Although you may be able to write this off at tax time, it’s money you don’t have available to cover the expenses associated with the work today. Non-payment can create cash flow issues that ripple through your business.

You Can Make a Credit Limit Determination with Data

Using a standardized process to determine approval and credit limits can give you greater confidence when making finance and growth decisions. Moreover, if every customer is subject to the same process and decision-making criteria, you can reduce or eliminate bias and discrimination claims.

How to Evaluate a New Customer Before Extending Terms       

Before setting payment terms, risk factors and creditworthiness can be assessed in a variety of ways.

Check Your Data First

Duplicates in customer relationship management (CRM) software are somewhat common, especially when systems only match customers by email address. Before you do a full assessment, check your existing system for businesses and contacts with similar names to confirm you don’t already have personal experience with the customer.

Verify Core Business Details

Begin with a credit application that requests the company’s legal name, any trade names or DBAs, entity type, federal tax identification number, physical and billing addresses, state of formation, ownership, and authorized contacts. Then, verify the information independently.

• Confirm the Legal Entity: Search the business registry maintained by the Secretary of State in the company’s formation state. Confirm that the legal name, entity type, formation date, registered address, and status match the application.
• Identify the Responsible Business: Determine which legal entity will make the purchase and owe the invoice. Parent companies, subsidiaries, franchises, and businesses operating under a DBA may share branding while remaining legally separate.
• Verify Ownership and Authority: Compare the listed owners, officers, or managers with state filings, a business credit report, professional licenses, and other reliable records. Confirm that the person requesting terms is authorized to act for the company.
• Cross-Check Contact Information: Compare the address, phone number, website, and email domain across public records and independent sources. Call a publicly listed number to confirm the buyer and accounts payable contact rather than relying solely on the number provided in the application.
• Investigate Discrepancies: Mismatches aren’t uncommon and can be caused by recent moves or reorganizations, but they need to be resolved.Ask for supporting documents if names, addresses, ownership details, or contact information conflict.

Review Their Credit Reports

Order a current business credit report from a commercial credit bureau such as Dun & Bradstreet, Experian, or Equifax. Each bureau uses different data and scoring models, so use the report’s rating guide and consider checking another bureau when the credit exposure is substantial or the available information is limited.

• Confirm the Company Match: Verify that the report belongs to the correct legal entity by comparing its name, address, ownership, industry, and identification numbers with the information confirmed earlier.
• Review the Credit Scores: Examine the company’s payment and financial stability scores. Focus on the risk category and contributing factors rather than comparing scores from different bureaus as if they use the same scale.
• Look for Serious Credit Events: Check for bankruptcies, judgments, liens, collections, and other public filings that could affect the company’s ability or willingness to pay.
• Assess Current Credit Exposure: Review the company’s outstanding balances, available credit, highest credit extended, and credit utilization when those details are available. Heavy existing obligations may reduce its capacity to take on additional credit.

Check Trade References and History

Your customer’s business credit report may already contain trade payment history from suppliers, including balances, credit limits, and payment patterns. If it shows several recent accounts comparable to the credit you are considering, you may have enough information to move forward without contacting references separately.

If the report is thin, outdated, inconsistent, or lacks experience at the proposed credit level, request trade references directly from the customer. Contact one or two comparable suppliers and confirm how long they have worked with the customer, the highest balance extended, and how reliably the customer pays.

Assess Financial Statements and Records

If the proposed credit limit, payment period, or risk concentration warrants a closer look at the customer’s ability to pay, ask for financial statements as well. Depending on the level of exposure, you may want to request recent balance sheets, income statements, cash flow statements, bank records, or financial statements prepared or reviewed by an accountant.

• Check Short-Term Liquidity: Compare current assets, such as cash and receivables, with obligations due within the next year. A current ratio below one means current liabilities exceed current assets and may signal difficulty covering upcoming bills.
• Review Operating Cash Flow: Confirm that the business generates enough cash through normal operations to meet its obligations. A profitable company can still struggle to pay if its cash is tied up in inventory or receivables.
• Evaluate Existing Debt: Examine loan balances, required payments, and other liabilities that compete for the same cash your customer will use to pay you.
• Compare Financial Trends: Review prior annual results alongside current interim statements. Declining revenue, shrinking margins, rising debt, or weakening cash balances may indicate increasing risk.

Research the Business and its Industry

Public records and current reporting can identify developments that haven’t reached a credit report or financial statement yet. Search the company’s legal name, trade names, owners, and key executives, then review reliable industry sources for conditions that may affect its ability to pay.

• Search Recent Business News: Look for acquisitions, ownership changes, leadership departures, layoffs, facility closures, lost contracts, or expansion announcements. Consider how each development could affect cash flow rather than treating every change as negative.
• Review Legal and Regulatory Records: Search federal and state court records, licensing databases, and regulatory actions for significant lawsuits, judgments, license suspensions, or compliance problems.
• Look for Operational Warning Signs: A disconnected phone number, inactive website, closed location, frequent address changes, or widespread reports of unpaid suppliers may justify further investigation.
• Evaluate Industry Conditions: Consider demand, costs, labor availability, supply chain pressure, regulation, and customer concentration within the company’s industry. Industry pressure carries greater weight when the customer already shows signs of financial strain.
• Confirm Material Findings: Verify important information through another reliable source or ask the customer for an explanation. Lawsuits, closures, and ownership changes vary widely in significance, so focus on developments that could realistically affect payment.

Perform a Thorough Customer Creditworthiness Assessment

Consider the full picture rather than letting one score or document control the decision. Weigh the consistency, severity, and timing of the findings, along with the potential loss your business would face if the customer failed to pay. Document your conclusion and the information that supports it.

Red Flags When Evaluating Customer Credit

Certain findings should serve as red flags to decline credit or at least pause the process to request more information and investigate further.

• Unverifiable Business Information: Don’t extend credit until you can confirm the company’s identity, ownership, address, and authority to open the account.
• Material Inconsistencies: Pause the review when the application conflicts with public records, credit reports, financial statements, or information provided by company representatives.
• Serious Payment Problems: Recent collections, judgments, unpaid balances, returned payments, or repeated late payments are a sign to reevaluate the customer’s eligibility for credit.
• Signs of Financial Distress: Declining revenue, recurring losses, weak cash flow, excessive debt, closures, or layoffs may indicate that the customer lacks the capacity to pay.
• Unwillingness to Provide Information: If a customer refuses reasonable verification requests or pressures you to approve the account before completing your review, it’s often safer to walk away from the deal.
• Unusual Purchasing Behavior: Investigate further when a new customer immediately requests substantial credit, places orders that don’t fit its operations, or requests delivery to an unrelated location.

How to Set and Manage Customer Credit Terms

At this stage, you’ve completed a basic evaluation and determined that your customer has no major financial red flags. The next step is to frame out your agreement in a way that limits your risk while facilitating a positive customer relationship.

Set the Credit Limit

A credit limit establishes the maximum unpaid exposure your business will carry for a customer at one time. Base it on the customer’s expected purchasing needs, demonstrated payment capacity, overall risk level, and the amount your business can afford to carry while waiting for payment.

• Estimate Normal Credit Usage: Calculate how much the customer is likely to purchase during a typical payment cycle so the limit supports expected activity without creating unnecessary risk.
• Match the Limit to Available Evidence: Compare the proposed amount with the customer’s financial capacity, reported credit limits, highest balances carried, and experience managing accounts of a similar size.
• Consider Customer Concentration: Evaluate how much of your total accounts receivable the customer would represent if the full limit were used. A financially strong customer can still create substantial risk when it accounts for a large share of the money owed to your business.
• Count Total Committed Exposure: Include unpaid invoices, delivered but uninvoiced work, and approved orders or projects that will draw against the account. This prevents new commitments from pushing exposure beyond the intended limit.
• Use a Modest Starting Limit: Give new customers enough credit to establish a payment record, then consider increases after they demonstrate reliable payment performance.
• Control Limit Exceptions: Require additional review and approval before accepting transactions that would exceed the established limit. Record temporary increases and the reason they were granted.

Choose the Payment Terms

Payment terms establish when and how the customer must pay, along with any protections required before your business provides goods or services. Tailor them to the customer’s risk level, purchasing cycle, financial capacity, and the amount of cash your business must commit before receiving payment.

• Set the Payment Period: Choose a due date that reflects the customer’s demonstrated ability to pay and your capacity to carry the receivable. Shorter periods reduce exposure for new or moderate-risk customers, while longer periods may be appropriate for established customers with strong financial and payment records.
• Require an Initial Deposit: Consider requesting a deposit when fulfilling the transaction requires substantial upfront spending on inventory, materials, labor, or subcontractors. The deposit can cover some or all of the costs your business would struggle to recover if the customer failed to complete the purchase.
• Use Milestone Payments: If work is project-based and those projects can take months, consider breaking them up into milestones or stages with individual payments. This approach is more common for businesses in industries like oilfield services or construction, and for businesses that provide professional services.
• Consider a Personal Guarantee: A personal guarantee can provide an additional source of repayment when extending credit to a new or closely held company. Have the guarantee prepared or reviewed by qualified legal counsel so the obligations are clearly established.
• Set Conditions for Higher-Risk Transactions: Require advance payment, additional security, or separate approval when a transaction carries greater risk than the customer’s standard activity. This may include unusually large purchases, custom work, or orders that cannot be resold.

Document the Credit Agreement

Put the approved credit arrangement in writing before providing goods or services on credit. Aim to create an airtight agreement that removes all ambiguity about payments and credit for all parties involved.

• Identify the Legal Parties: Use the customer’s verified legal name and identify any DBA, guarantor, parent company, or subsidiary involved in the transaction.
• State the Credit Limit: Specify the maximum unpaid balance permitted and explain how pending orders, delivered goods, or uninvoiced work count toward that limit.
• Define the Payment Requirements: State when invoices become due and identify any deposits, milestone payments, advance payments, or other conditions required.
• Explain Late-Payment Policies: Describe applicable late fees, interest, collection costs, service suspensions, and other consequences permitted by law.
• Establish a Dispute Process: Explain how and when the customer must report billing errors, shortages, damaged goods, or service concerns.
• Reserve the Right to Make Changes: State that your business may reduce, suspend, or withdraw credit when payment performance or risk conditions change.
• Obtain Proper Authorization: An authorized representative should sign the agreement before the account becomes active. Personal guarantees and other security documents should also be properly executed and reviewed by qualified legal counsel.

Monitor Payment Performance

Once your customer is active with your business, you can use their actual history to determine ongoing creditworthiness.

• Review Accounts Receivable Aging: Your aging report should show every open invoice, its due date, the amount outstanding, and how long it has remained unpaid.
• Compare Payments with Agreed Terms: Record if the customer pays early, on time, or late and track how far payment timing varies from the agreement.
• Track Partial Payments: Repeated partial payments, broken payment promises, or requests to divide overdue balances may indicate cash flow pressure.
• Examine Disputes and Deductions: A growing pattern of billing disputes, deductions, or delayed approvals may signal financial strain, operational problems, or dissatisfaction that could affect collection.
• Watch Purchasing Patterns: Sudden increases in order size, accelerated purchasing, unusual products, or repeated attempts to use the full credit limit may indicate a change in risk.
• Document Customer Communication: Keep records of collection contacts, explanations for delayed payments, promised payment dates, and any commitments made by the customer.
• Set Account Alerts: Use accounting software or internal controls to flag overdue invoices, approaching credit limits, returned payments, and other events that require review.
• Respond to Risk Changes: Reassess the account when the customer requests substantially more credit, payment behavior deteriorates, financial conditions change, or other warning signs emerge. Update the relevant information and maintain, reduce, suspend, or withdraw credit based on the findings.

Reduce Your Workload and Risk with Viva Capital

If you’d like to accelerate customer payments and skip the credit check headaches, Viva Capital can help. We offer a variety of business funding solutions, including invoice factoring. As part of the factoring setup process, we examine the creditworthiness of your customers and provide insights into how much credit can be extended without exposing anyone to unnecessary risk. If your customers are creditworthy, we can then advance most of an invoice’s value as soon as goods or work are delivered. You can also opt for non-recourse factoring. It offers an extra layer of protection by transferring the risk to Viva if your customer doesn’t pay in special circumstances, such as insolvency.

To learn more or get started, request a complimentary rate quote.

Disclaimer: This information is for general purposes only and does not constitute legal or financial advice. Consult qualified legal and financial professionals about your specific circumstances.