A strong credit application is one of the most important foundations of every business. Importantly, it guides the work of the credit department, whose work relies on strong credit application documentation. Here, we explore what a sound application looks like, as well as common pitfalls and how to overcome them.
How to create the application
The first step is to ensure the business understands the audience for the credit application and its objective, says Anna Taylor, principal, Results Legal.
“Right from the start, think through your objectives, what you want to achieve through the credit application and how you want to run credit management. If you don't have a good credit application, you're not going to have good credit management. Speak to a lawyer about how you want to set it up because it needs to be specific to your business.”
Taylor’s advice at the start of the process is to make a series of business decisions. Agree whether the business requires a personal guarantee or security with credit applications and whether it intends to enforce its rights over these. “Do you want a customer-friendly credit application or to take a more hard-line approach?” she questions.
Nova Legal director Raffaele Di Renzo says the best way to create the application is with a legally binding agreement that clearly sets out all parties’ obligations. “This includes ensuring the agreement is between the correct parties, the parties properly execute the agreement and the agreement’s terms are unambiguous and fair for all parties.”
Other issues that require resolution upfront include whether the application will be available online or in hard copy, or both. The breakout box below explores this further.
Mandatory fields – and specifics
The application must uncover who the credit department is dealing with, for instance a company, a trust or an individual.
“You'd be surprised how many times businesses don't know who they're dealing with when their customers complete a credit application. So, getting the full details of the identity of your customers is very basic but important,” says Taylor.
When it comes to mandatory fields, Di Renzo says there should be a term or field that grants credit to the applicant and how much that may be, so everyone is clear on the credit limit.
“There could also be a term that relates to payments owing and if there are payments owing under the credit agreement to the credit provider, how those payments should be made.”
Malcom Field, director of accounting practice SV Partners, says it’s imperative to ensure the application template properly reflects the business and the goods and services provided and the particular credit risks applicable.
“Get buy in from the sales team who ultimately need to implement the form and consider legal advice to be sure it will be effective. Ideally, you will obtain a personal guarantee and some form of security such as charging right over the goods supplied, proceeds from the sale of those goods, the business real property and the proprietor or director’s real property,” he says.
Field also recommends including a checklist of annexed items and personal financial positions with any trust assets noted.
The application must also set out retention of title if the business is supplying goods and its rights to be indemnified of any expenses such as collection costs. It should also include information about the interest rate that will be charged for late payment. This may be something the business is prepared to negotiate down the track to achieve a successful outcome, says Taylor.
“If you're trying to resolve an outstanding debt, the business may agree to waive interest. In this case, the agreement should include a variation clause that relates to how the agreement may be varied,” she says.
According to Taylor, in circumstances where a business has entered into a credit application some time ago and wishes to update it, ensure it has the ability to refer to pre-existing credit applications as well as the new credit application to form the entire agreement. This avoids the risk of the business losing priority with respect to security. She also says the privacy statement must contain all the necessary consents the business requires to undertake searches on any individuals involved in a credit application.
However, Taylor notes the specifics included in credit applications will be different for every business. For instance, some will attach quotations to the contract, others will include detailed information about delivery times. Return policies can also be unique, depending on what is being supplied, as can payment terms and how the business accepts payments.
“Some businesses will only accept payments through EFT, some require a direct debit. The ability to make a claim, if the goods have defects, is also usually business-specific,” she says.
The application should be supported by credible trade references with full contact details, says Nick Cooper, a partner with accounting firm Worrells.
“Where the applicant is an individual or a partnership, it's very important to get dates of birth. While you don't need a date of birth to commence legal action and get a judgement, it is needed down the track if you wish to apply for bankruptcy against an individual.”
This is because there are many people with the same name, and without a date of birth it's almost impossible to isolate assets owned by the individual. “Banks won't respond unless they have the date of birth as well as the name in a judgement,” Cooper warns.
The application also needs associated financial information that supports the ability to repay the credit. Cooper says this may include financial statements, asset and liability statements and letters vouching creditworthiness from finance companies.
“For company applicants, it’s useful to have its history and background and how long it's been in business. Also do company searches and make sure the directors on record are the directors signing the application form, so there's no issue about the application form not being correctly executed by the company,” he says. It’s also recommended to check the company is properly registered and not subject to external administration.
Once the credit application is drafted, there are various points at which the business should seek legal advice. For instance, when there are legislative changes that may affect credit applications or when another company is added to a group.
“Many times, we have had clients come to us where they've set up a credit application years ago and they have tried to update it themselves and it's a mess. It's really important, not just during the initial drafting, but any time the application is updated, to seek advice to avoid mistakes,” says Taylor.
Di Renzo says it’s also essential to seek advice when enforcing the terms of the agreement.
Overcoming pitfalls when assessing credit
There are many common pitfalls businesses fall into when collecting information on credit applications. Sole traders not providing an ABN or not including information about the trustee of a trust applying for credit are two common ones, says Taylor. A corporate entity not providing personal guarantees is another.
“Or, you might be dealing with a corporate entity but discover it has no assets, which may pose problems should the business be required to recover debts. Proper assessment of the creditworthiness of the applicant is another issue,” she says.
To mitigate these risks, Taylor’s advice is to extract as much information as possible from the outset. “Know who you're dealing with and their credit history by performing searches,” she recommends.
Field says other pitfalls include incomplete application forms. “Don’t supply until it is complete.” He also says it’s essential to ensure the content is inaccurate. “Run a land title search to confirm property ownership.”
Additionally, if there are any concerns regarding the viability of the business ensure there are appropriate insolvency clauses included in personal guarantees.
“There are lots of clauses businesses can put into credit applications that mitigate the risk of loss. For instance, should the corporate entity enter into insolvency, it can stipulate to choose the guarantor in the event of a claim,” she says.
Case study: BGW Group goes online
Jane Hay, BGW Group’s accounts receivable and credit manager, says her business switched to online about three years ago and is now reviewing the online application for the first time. The company processes about 300 new accounts each month.
Hay says after initially replicating the hard copy form online, it’s now time for a review. “The company has evolved and processes have changed, so we’re going to add and subtract some information.” The business also wants to ensure the application is able to be accessed through all mobile devices and operating systems.
The credit limit that the customer wants is also important. “They have to give us a limit, but the application includes terms and conditions to allow us to change the limit. But we don’t ask for director details because that’s included in the mercantile report, which also gives us trade reference footprints.” Companies must also include a signed deed of guarantee.
*Alexandra Smith is a freelance finance journalist who has written for many leading Australian and international business publications
December 2018 - FNSCRD401 - Assess credit applications - FNS40120 Certificate IV in credit management