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Reducing Credit Risk In The New Economy
By Mark Vengroff

As bankruptcies and unemployment continue to rise, and the fourth quarter shows signs of an even weaker economy, companies are tightening budgets and re-assessing how much risk they can endure. In preparing your internal credit department for the rapidly changing financial environment, here are five steps you should follow:

Step 1: Arm your credit analysts with current and accurate databases that contain credit and financial information on your customers

Balance statements are a great tool in evaluating the financial stability of a company, but as the market demands change, some companies may find themselves in a quick financial downturn. Using various credit bureaus and other sources of information including commercial databases can be very helpful in gathering more current data on a customer's current trends and credit history. For smaller companies, looking on-line at the Secretary of State's websites will give you valuable information about the active or non-active status of a corporation. This additional information allows your company to better assess the risk of doing business with current and potential customers..

Step 2: Use a Risk Assessment Matrix to determine the potential delinquency or default.

Entering in the data received by the customer's financial statement, credit application, feedback from credit and banking references, and on-line databases into a simple matrix CAN BE an easy way to assess your customer base in a fair and consistent manner. A matrix can be designed by assigning a value to each of the fields identified within your matrix. A negative value would be assigned to missing or incomplete data where none is available. For example, if you were unable to obtain any trade references or the application was incomplete a negative value would be added [rather than a zero value].

Step 3: Use Scoring Models to assign acceptable credit limits.

After adding the values assigned to the risk assessment matrix, a total score can be determined. Once a series of ranges has been determined, credit limits can be assigned to the ranges. There are also many companies on the market that are offering computerized credit scoring models to evaluate customers' credit worthiness. Those models are usually not Industry Specific or are only as accurate as the number of companies reporting to them, but they can provide an inexpensive and quick alternative to the labor intensive and subjective process of contacting references, reviewing credit reports and arriving at a decision about what credit limit and credit terms are appropriate.

Step 4: Build a treatment schedule to determine the level of follow up required based on the customer credit risk score.

The treatment schedule must, by design, allow for more aggressive follow up on customers that score poorly in the assessment. For customers that present a greater risk of default or serious payment delinquency, soft collection calls can be made to ensure that the product or service was delivered and/or met the customer's expectations, and to confirm that payment has been scheduled. By calling one to three days after the invoice is due [or if possible, following up with the customer prior to the invoice due date] allows you more time to start delving into the route of potential problem accounts or weeding out invalid disputes prior to delinquency.

Companies should be in the habit of building new treatment schedules to challenge the standard operating procedure for comparison and continued improvement within the department. If successful, the newly created challenger process becomes the new standard by which you operate... and then a new challenger is created.

Step 5: Create a Credit Reassessment Schedule for the frequency of re-evaluating potential risk with current customers and adjustments of credit line.

Build a schedule to re-assess your current customer base on a regular basis. Many companies build credit over time and run into high exposure due to length of the customer/client relationship. Companies are now starting to request that current clients complete a new credit application form if the application on file is over two years old. Updating your records with the latest financial statement every year is also good practice from a credit risk control standpoint.

Re-assessing your customers is always a good practice for ensuring proper risk management and financial growth in your organization. By following these five steps, your company can establish long-standing relationships with creditworthy potential and existing customers.

Mark Vengroff is Chief Executive Officer, Vengroff, Williams & Associates, Inc., California. His email address is:

Reprinted with permission from the© 2002 Covering Credit Newsletter.
All Rights Reserved. 9/25/02 Edition

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