Managing Customer Credit Risk
23-04-2021 5 min read
Assessing your business partners’ creditworthiness involves checking their financial situation. This is a key activity for every credit manager. Your business partners’ financial situation must be stable enough to ensure they can fulfil their obligation to pay any credit you might grant them for goods and services provided by you. Checking a business partner’s creditworthiness is an important foundation on which to assess the amount of risk you are willing to take and to make a solid credit decision. There are different sources of internal and external data that credit managers can choose from, depending on how much credit is needed and how cost-effective obtaining the information is. External data are used to assess the risk that comes with a certain business relationship and to make a sustainable decision that both helps to enhance the relationship with the customer and that protects your business from the risk of payment defaults.
Informed Credit Decisions
Credit decisions are based on a customer’s credit rating and credit demand. Making a decision on how much credit to give a customer is a key activity within the credit management process. A variety of data is included, such as credit demand, external credit rating, customer’s past payment behavior, open balance, dunning level, payment terms, securities, etc. Credit managers use this information to derive different credit parameters, such as credit limit, an internal credit score and risk category. Based on these parameters, credit managers are in a position to make solid decisions to protect their business against the risk of non-payment. Credit management, however, can only do their job right and help to minimize the risk to the company if it has high-quality data and solid information available to base their decisions on.
Continuous Monitoring of Customer Risks
Credit monitoring is a very important component in every organization’s credit management. This means putting in place an ongoing monitoring of business partners and a systematic credit check, which can be carried out based on individual customers, groups of customers, credit rating or the amount of credit granted. The credit monitoring process checks that the credit limit granted to a customer is not exceeded, that payments are made on time and that credit securities are still valid and sufficient to guarantee a customer’s credit. It also involves regularly checking and updating all the data that the original credit decision was based on, such as customer’s current credit rating, payment behavior, buying behavior, etc.
Credit monitoring needs to ensure early identification and proper assessment of increased risk that can result from a drop in credit rating or a loss in value of the credit securities provided by a customer. Armed with key insight and up-to-date information, credit managers are in a position to trigger follow-up activities within the credit management process. A positive risk trend indicates that the relationship with the customer may well be expanded, while a negative development calls for reducing or securing the risk. In terms of reducing or preventing risks, credit managers have a variety of options at their disposal, such as reducing a customer’s credit limit, blocking a business partner, putting orders or deliveries on credit hold, adjusting a customer’s payment terms, intensifying dunning procedures, etc.
Minimize Credit Risks Through Securities
Securities management is an important credit management tool aimed at minimizing the risk of bad debt. Securities are assets (tangible items and rights) that can protect a creditor against the risk of a debtor defaulting on their payments. Banks and financial institutions usually always ask for securities in their medium- and long-term product portfolio because it is impossible to guarantee a borrower’s ongoing creditworthiness due to unpredictable future economic developments and granting unsecured credit entails unacceptable risks.
Identify Credit Risks Through Balance Sheet Ratings
Balance sheet ratings play an increasingly important role in today’s risk management. Balance sheet ratings allow companies to properly assess risks and make informed decisions. Being aware of a business partner’s future ability to meet his financial obligations is of crucial importance to investors and loan providers. For issuers, balance sheet ratings are an important instrument in securing their investor’s trust and these ratings are an important element within their financial communication for the rated companies.
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