When evaluating credit worthiness, there are many factors to consider, the most obvious of which is the debt history of the company to which credit is being extended. But there are some external elements many neglect to consider. Environmental factors, particularly water scarcity, aren’t issues most credit professionals would think to track, but they have a notable impact on creditworthiness up the value chain.
Direct impact of water scarcity
When examining the effects of water scarcity, agriculture and utilities are the most obvious industries to consider. Agriculture alone accounts for 70% of global freshwater use, and water cutoffs lead to water utility companies losing money. But less obvious to most are the other industries affected by water shortages. The textile industry is another of the highest water consuming sectors in the industrial world. Dyeing fabric requires an extraordinary volume of water.
Transportation is also water dependent. Ships transporting passengers and goods have trouble navigating in shallow water. This summer’s grounding of the Ever Given in the Suez Canal was a rather dramatic example. Though weather and human error contributed to the supply chain disaster, shallow water also played a part.
Effect on the value chain
For each industry directly affected by water scarcity, a ripple effect spreads throughout the supply chain. For example:
- Drought decreases production in agriculture.
- Volume is reduced for overland transportation (e.g., trucking and railroads).
- Industries reliant on produce deliveries — such as grocery stores and restaurants — suffer shortages.
This is only one example. Each industry creates its own ripples in the chain, and different chains branch off from those. When evaluating creditworthiness, it’s critical to examine supply chain connections between industries.
Water scarcity creates uncertainty for businesses within affected industries, and uncertainty is the enemy for creditors. Decreased production leads to decreased profits — which increases the likelihood of account delinquencies. To evaluate when it’s safe to extend credit, it’s crucial to understand connections between industries throughout the supply chain. Diagram industry overlap and assess the potential consequences of — predictable and unpredictable — external factors before extending credit. Consider enlisting expert help to analyze more complex interactions.
Evaluating creditworthiness is one of the first steps in extending credit to a client. Commercial credit professionals know the importance of examining a business’ past performance and future projections, but environmental and other external factors are often overlooked. Water scarcity has deceptively far-reaching consequences. The availability of water — and how it affects the industry or business in question — should always be considered.