Money Matters

How to spot good and bad trade references when extending credit

Trade references can offer valuable insight into a company’s creditworthiness—but not all references are created equal. Learn how to identify strong, relevant trade references, spot red flags, and ask the right follow-up questions before extending business credit.

Business trade references play an important role in creating an accurate picture of a company’s payment practices. They can sometimes be your most powerful and valuable source of information when determining customer creditworthiness. However, just because a business has a credit reference to offer doesn’t necessarily mean it’s a good one. Here’s how to distinguish between good and bad trade references and key questions to ask before extending business credit.

One good indicator of the difference between a good and bad trade reference is its origin. If the business can provide a credit reference from within the same industry, that is a good indicator of how quickly you will get paid. If they provide a reference from outside the industry, such as their electric company, it may not be as indicative of their payment history since you must pay the electric bill to keep it on. These, of course, are not the only types of businesses that can be valuable credit references; below are a few other examples of good and bad sources of information.

What makes a good trade reference?

A good trade reference gives you a solid understanding of a company’s ability and likelihood to repay credit. But what sets a good reference apart from a bad one? The key lies in the source of the reference and the relevance of the information provided.

One of the best indicators of a valuable trade reference is whether it comes from a business within the same industry. Industry-specific references are the most useful because they reflect payment practices similar to your experience when dealing with this company. A reference from an unrelated sector—such as their electric company—may not give you the full picture, as paying utilities is mandatory. While such references are important, they don’t always shed light on payment behaviors tied to trade credit.

Examples of good business trade references

Now that we know the source of the trade reference matters. Let’s look at specific examples of good trade references that can provide relevant insight into a company’s creditworthiness.

• Accountant / CPA
• Freight, trucking, or local delivery service provider
• Landscaping company
• Lawyer
• Advertising
• Payroll services
• Marketing service provider
• Software developer
• Supplier of parts/materials
• Uniform supplier
• Website design/host company

Examples of bad business trade references

On the flip side, not all trade references are equally useful. Here are a few examples of bad trade references that won’t provide the insight you need to make informed decisions.

• A bank
• Insurance company
• Real estate company
• Utilities company

Questions to ask during follow-up with business trade references

Finally, just because a “good” trade reference has been provided doesn’t mean you shouldn’t follow up. Many companies ask for them and then they don’t take this next step…so what’s the point of having them? There are many questions you can ask when you follow up with business credit references, for example:

• How long has Company A had an open account with you?
• What is their credit limit with you?
• How many times have they been late? How late?
• Is there a seasonal pattern to their payment behaviors?

Both a credit application and business trade references should be part of your overall credit and collection policy and action plan, a document that outlines the rules, regulations, and expectations of not only your customers but also your staff. They can significantly protect your business from unnecessary credit risk while allowing you to reap the benefits of selling to the right customers on credit.