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Mastering a Credit Risk Management System for Business Success

Ann Marie Smith

5/1/2024

What Is a Credit Risk Management System?

When you operate on credit, you provide goods or services upfront and then invoice your customers for payment at a later date. A credit risk management system or credit risk management framework is crucial to mitigate risk with trade credit and make smart decisions when giving your customers time to pay. Extending the right amount of credit to qualified buyers reduces your risk of default or late payment.

Credit Risk Monitoring

When you extend credit, this becomes your accounts receivable (A/R). The more credit you give, the larger the A/R balance and the more exposure you have. This also impacts your cash flow and working capital.

Unfortunately, not all businesses are good credit risks. Some may be struggling—even if outwardly, they do not appear to be. Some may not pay their bills on time. Others may be on the verge of bankruptcy.

While you have to take some risk when selling on credit, a credit risk management system can help lower your risk and set you up for success. Key to that success is credit risk monitoring when onboarding new customers, plus ongoing monitoring as things can change quickly.

A credit risk management system focuses on identifying potential risks and mitigating exposure.

What to Look for Before Extending Credit

When evaluating the risk of trade credit for customers, here are some of the key factors you want to take into consideration.

Overall Financial Health

You need a good idea of a company’s overall financial health before extending credit. You can look to a business credit report for the business credit score as a good general indicator. For public companies, you may also be able to access financial statements. For private companies, you would need to depend on them to provide you with this information.

It is also a good idea to understand their family tree. For example, a subsidiary of a business that is having financial trouble is a greater risk.

Business Verification

Unfortunately, business fraud is a significant concern. To give you an idea of the scope of the problems, lenders file more than 3.6 million suspicious activity reports (SARs) to the U.S. Treasury Financial Crimes Enforcement Network each year.

You want to ensure you are doing business with a legitimate company. Business verification can help match identities so you can be sure of dealing with a legitimate business.

Credit and Payment History

Regardless of what a business tells you or provides on a credit application, you need to check their credit history. Look for how they have used credit in the past, whether they are delinquent on any current accounts, and how quickly they pay. If they are having problems paying their bills on time with other companies, your exposure increases.

Some business credit reports will provide tradeline summaries, allowing you to see how much they owe so you can evaluate their creditworthiness.

You also need to evaluate the impact of slow pays or no pays on your working capital and cash flow. Will this order put you at financial risk?

Account Balance

You need to take into account how much they already owe you and the history of past payments. Are they current with their account, and do they pay according to the agreed terms?

Volume

The size and the nature of the order they are placing will also play in role in the credit you extend. You want to maximize your sales revenue, but you also must mitigate your credit risk. You probably have to pay suppliers for goods or materials or pay to develop and deliver services. You want to balance the risk with the revenue.

Terms

Credit decisions are about more than just “yes or no.” You may want to extend credit under various terms depending on what you find in a business credit report. For higher-risk customers or customers in high-risk industries, for example, you may want to shorten net payment dates, ask for progress payments or deposits, or require payment upon delivery.

Get Business Credit Reports On-Demand

Business credit reports provide the foundation for credit risk monitoring. In the past, you typically had to sign up for a subscription service to analyze business credit reports. That is no longer the case. With Command Credit, you can get business credit reports on-demand from leading suppliers like Equifax, Experian, or Dun & Bradstreet. Each of these companies provides slightly different information to help you with credit decisions.

Get reliable business credit reports from Equifax, Experian, and Dun & Bradstreet on-demand at Command Credit to anchor your credit risk management system.