Most businesses must deal with credit risk. It’s unavoidable, but that doesn’t mean you can afford to ignore it. Although credit risk can’t be eliminated, it can be managed and mitigated through sound commercial credit risk management practices.
Whether you’re the sole member of your credit management department or you work alongside a team of credit risk managers in a large financial institution, it’s important to have clear, written credit risk management guidelines. All team members need to understand their roles and must consistently implement your documented procedures and processes.
Create a credit risk management policy
A written credit policy is essential for any business involved with extending credit. This is an important tool to gain consistent alignment with credit policies throughout your company, and it communicates consistent standards for your customers.
Creating a written document starts with assembling a credit management team that will oversee all aspects of establishing and carrying out the policies. Even if the department consists of only a couple of people, you need to outline each team member’s roles and tasks and have measures in place to make them accountable. Upper management must approve the policies and support the team in carrying them out. In addition, the fast-changing world of finance requires that credit risk management policies are reviewed regularly.
Your credit policy should include the process you go through to grant or deny a credit request, including credit administration processes, analytical tools for determining credit worthiness, steps to take in case of customer delinquency, and collections procedures. The written document should outline expectations and goals and enhance cooperation between your sales and finance departments. It’s your go-to document when credit questions or problems arise within the company.
Know your customer
One of the fundamental keys to good credit risk management is understanding your customer. The best approach is a face-to-face interview. If possible, do some research beforehand so you know what questions to ask. This will show your credibility as a professional, knowledgeable, and friendly business person.
In addition, you can better understand your customer’s credit risk if you understand the company’s industry, products and services, management, customer demographics, suppliers, and history. Who is their competition, and what are the possible impacts of economic conditions on their company? What is the purpose of the credit extension?
It’s important to establish a mutual trusting relationship — not only for the current credit extension but also for future financial dealings. Keep in mind that some customers may expect you to extend credit based on relationship. Although every situation and customer are different, it’s important to still conduct a thorough risk analysis.
Choose the right risk management tools
Hundreds of credit risk management tools are being developed every day. Depending on your company’s size, needs, and technological expertise, you can either select standalone solutions or implement a complete solution. The primary types of tools for managing credit risk include:
- Credit analysis tools — These tools collect data from many sources of financial records and analyze the data to determine how well a company is paying its debts, whether it can afford to invest and create further revenue, and how efficiently it’s operating.
- Credit risk modeling tools — These types of tools use historical financial and behavioral data to predict how likely a customer is to default on a loan, as well as the impact on the lender if the customer defaults.
- Credit limit calculators — These tools leverage data such as business volume and the financial capabilities of your customers to set credit limits consistent with their financial strength.
New and improving technologies such as artificial intelligence (AI), big data, and blockchain are continually changing the credit risk management industry. Risk management professionals are using these technologies, along with other credit management tools, to better assess financial and non-financial data, thereby enhancing the accuracy of their credit risk management efforts.
Credit risk management is vital to the cash flow and financial health of your company. But it can be daunting to ensure you have the right team, tools, technologies, and time. Every component of your commercial credit risk management is important. For many companies, partnering with a reputable third-party provider is the perfect solution to a sticky problem.