Credit Risk Management Best Practices

For many companies, extending credit is an integral part of doing business. Not only can extending credit encourage sales and give companies a competitive advantage, but it can also build customer loyalty and deepen customer relationships.

However, extending credit can also expose a company to financial risk if customers are delinquent in their payments. Thus, it is important to have sound policies and processes in place to effectively evaluate customer creditworthiness, set appropriate terms, and manage delinquent accounts.  Following these steps will enable your company to successfully extend business credit and enhance customer relationships.

Establish a Credit Policy

Credit policy is designed to protect a company against the financial risks caused by customers who can’t pay on time or at all. At its most basic, a credit policy determines which customers are extended credit, sets payment terms, defines credit limits, and directs how delinquent accounts will be managed. Your credit policy should be well documented and reviewed on a regular basis. Every six months is recommended. If there are significant changes in the economic climate or customer payment patterns, you should update the policy more frequently.

Use Data to Make Credit Decisions

To ensure that you are taking the right steps to protect your company against credit risk, you need to stay informed about the financial condition of the companies with which you do business. To get a reliable view of a company’s financial condition, it is important to gather accurate, up-to-date information from a variety of sources. In addition to collecting information from the company itself, many credit managers leverage business credit reports, bank and trade references, and/or public records. They may also compare a company’s performance with that of industry peers.

Business credit reports are an essential risk management tool for many companies because they consolidate all the critical information needed to assess credit risk in one place.  They are created by companies specializing in business credit that collect, verify and analyze pertinent information from numerous sources, including public records and filings, as well as trade references.  The reports also contain scores that rate a business’s creditworthiness and predict its payment behavior.

Clearly Communicate Terms and Payment Expectations

Clear communication helps avoid confusion about expectations or commitments, which can lead to late payments and create tension between you and your customer. Make sure payment terms are clearly documented and understood.

Actively Monitor Your Customer Portfolio

Credit risk management is a dynamic process. As conditions are constantly changing, it’s important to review the creditworthiness of existing customers on a regular basis so you can proactively identify risks and opportunities. For example, you may find that an existing customer’s business is growing, and their financial condition is very strong. In such a case, you might consider raising the company’s credit limit to encourage more sales. On the flip side, you may discover that an existing customer is paying other vendors late and its creditworthiness is deteriorating. In such a case, you should proactively reach out to the customer so you can learn more about the situation and work together to address it before it becomes a problem.

In addition to monitoring a company by pulling its business credit report on a regular schedule, you can sign up for alert monitoring services that are offered by business credit report companies. These services send you alerts if there are changes in a company’s business credit report, such as credit score changes, new credit tradelines, and bankruptcy filings.

Proactively Manage Delinquent Accounts

Effectively managing customers who don’t pay on time is critical to the health of your business as they can wreak havoc on your cash flow and financial stability, if the situation gets out of hand.

Contact us to discuss how you can incorporate these tools into your credit risk management processes.