Businesses should not overlook the advantages of extending more credit to their customers: extending credit can help build customer loyalty, encourage them to apply for more credit, and give your business a competitive advantage over less generous partners.
However, there is a fine line between enjoying these benefits and suffering the risks that come with providing goods and services to your customers, but now with a later payment date than usual.
Credit risk management is the practice of determining creditworthiness and creditworthiness based on financial health, which can indicate the ability to pay on time. If a customer does not pay, the balance must be referred to collections or marked as bad debt, and neither of these options is desirable for the lender.
How can we define solvency or credit capacity?
Solvency is found in the dictionary as “ability to meet debts,” which we can further explain as the ability to generate funds to meet long-term financial or credit commitments made with a third party. If you are a company looking for a business line of credit, it is important to imagine how your suppliers would view you and what their concerns might be when considering it. Most of the time it comes down to this: is your company capable of paying a debt in full, on time, and within the required timeframes and terms?
While you can consider subjective criteria when determining a client’s creditworthiness (for example, whether the client seems easy to work with), objective criteria are what can really reveal the truths your client can’t or won’t openly disclose. These criteria include things like whether financial statements show sufficient cash flow or liquidity or whether business references demonstrate the company has a history of making on-time payments.
We can summarize the most enriching and important elements of these objective criteria by talking about the 4 C’s of business credit:
What is the company’s financial capacity
to pay its bills? Does it have sufficient cash flow? Is it special database heavily burdened with debt? Business credit applications usually require the client to provide bank references, trade references, and financial statements. These documents will reveal the applicant’s ability to pay.
If the customer is unable to provide financial data or references, credit managers will need to find other ways to assess the company’s ability to pay. Many look at third-party credit reports like CIAL Dun & Bradstreet, as they can shed some light on the 3 tips for strategic supplier management potential credit risk of working with someone.
These are a company’s financial
and non-financial assets, as well as the amount of money its owners fans data have invested in it. If the assets listed on a company’s financial statement show growth, such as owning a fleet of vehicles instead of renting them, this can be taken as a lower risk of default.
Having a financial statement makes it easier for a credit manager to assess the applicant’s capital strength.
Some industries that require large investments in inventory and equipment may seem riskier than those that operate with lower overhead costs, but this is where the expertise of an experienced credit manager comes in. Their knowledge of various industries and trends can help assess financial strength relative to risk.
Applicants with questionable
credit history may be asked to provide collateral to secure their debt obligation for a high credit line, just like any other type of loan. Here inventory, machinery and other equipment listed as capital assets can be used as collateral.
While collateral offsets the risk of the lender, it is important to remember that businesses prefer to work out a payment plan with their customers rather than attempt to seize an asset as part of the collection process.
A smart credit manager can look at the bigger picture and consider whether a credit applicant has a special condition that could affect the decision-making process in any way. Things like the industry they belong to, their competitors, or their location could end up making the credit decision easier or harder.
Before decisions were automated,
the lending profession placed a strong emphasis on the character of the applicant and the professional relationship between the client and the loan officer. If they knew their client’s business well, they would be more willing to work with that account during periods of slow payments.
A customer who does not return calls or emails can hurt a business’s chances of applying for future credit.
Considering these four elements of creditworthiness and incorporating them into a standardized credit application review process is smart policy. The goal for finance is for them to begin thinking and operating as enablers of growth, rather than assuming the traditional gatekeeper position.