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Whether you're checking current or new customers, there are several reasons why it’s important to carry out credit checks.

Important risk assessment tool

Late customer payments are one of the biggest risks facing businesses. Chasing late payments costs money and can have a negative impact on your business. Carrying out a credit check can help you to protect the financial health of your own business.

Insight into customers’ financial situations

A credit check can provide detailed information about your customer’s credit history which will allow you to have the confidence to choose new customers or positively reinforce your relationship with current ones.

Help to set credit limits

It can be useful to offer customers credit, but the larger the amount of credit you offer, the greater the risk. A credit check can determine if credit should be offered and how much it should be.

Contribution to ongoing monitoring

Running credit checks on your customers and even your suppliers gives you valuable insight into the financial health of your entire supply chain, and allows you the insight to make an informed decision on credit-related issues.

Accurate and informed decisions

The information found in a credit report can be used to inform your sales strategy, helping you to approach potential customers who have the resources to pay you.

If you don't know a potential customer's credit history, there is a risk of being paid late or not being paid at all.

You should ask all potential customers to complete a form authorising you to get bank, credit and trade references.

The form should include:

• The full name of the customer's business and any other names it trades under.
• Details of who owns - and who runs - the business.
• The legal status of the business, eg sole trader, partnership, limited liability partnership, public limited company. For more on the various legal structures, see legal structures for businesses - an overview.
• Registration number - if it's a limited company.
• How much credit is being asked for.
• Full contact details of the person responsible for payment queries.
• Delivery and invoice address if different.
• Bank account details.
• A request for consent to make bank reference checks.
• A request for consent to get a credit check from a credit reference agency.
• A request for consent to get at least two trade references.

You should then make the necessary checks with the customer's bank, a credit reference agency and their suppliers.

In some circumstances, you might allow new customers credit without making the necessary checks in advance.

For new accounts making small orders, you could offer a 'fast-start limit' of around £500.

You could then apply the 80/20 rule to identify the largest accounts that make up 80% of sales. Once you have identified your most important customers, credit check them as necessary.

Ideally, all customers should be credit checked so that the amount outstanding from them is controlled and future sales efforts can be focused on your most reliable customers - there is no point wasting time on customers who represent a greater financial risk.

For more information, see credit checking potential customers.

Ongoing monitoring

You should try to monitor accounts for trends, eg slowing payments, detailed queries regarding deliveries which consistently lead to delays in payment.

If you think that you have a problem with a customer, make checks as necessary, by:

• using credit insurers
• getting sales or credit staff to visit the customer
• getting additional trade references

Other sources where you can get information on potential and new customers include:

•  - for checking a limited company's accounts
• - for information on the Enforcement of Judgments Office (EJO) cases
• - a registry of individual voluntary arrangements and bankruptcies
•  - league tables of payment times for all public limited companies in the UK
• local newspapers
• online searches of individuals and businesses

If you are still unsure about the creditworthiness of a customer, you could consider having a third-party guarantee. This is a legally binding agreement with a third party that they will pay if the customer does not.

You also need to make sure your terms and conditions are correct for any credit you set up - see invoicing and payment terms.

It may be difficult to determine the amount of credit to give - particularly with a potential or new customer.

You can therefore get a:

• credit check from a credit reference agency - see credit checking potential customers and credit checking new customers
• decision from a credit insurer

Alternatively, you could make the decision yourself and set a credit limit for each customer. You should set a customer's limit according to how good their credit rating is. If their credit rating is good, you could set the limit at double their monthly sales figure. The limit should be reduced for those customers with poorer credit ratings.

The limit will need reviewing as potential sales levels change. Make sure your staff are aware of each customer's credit limit.

Risk codes

You could also devise a simple system of risk codes to apply to each account, for example:

• A (low risk) - customers with the best credit references and payment records
• B (average)
• C (high risk) - those who your credit checks reveal have had, for example, county court judgments made against them and are therefore most likely to be slow payers
• N (new) - customers you have traded with for less than six months

Once you have identified your 'C' customers, it might be better to concentrate sales efforts on the 'A's and 'B's.

However, if you can't get enough business from 'A's and 'B's you might still have to take on some 'C' accounts - there may be good profit to be had from 'C's if you monitor them carefully and minimise your risks.

You should also ensure you review the system from time to time.