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Mountain States Commercial Credit Management – elevated credit and collection services since 1988. Call us to improve your cash flow.    800-457-8244

Why You Need a Credit Risk Scoring System

Managing your company’s B2B credit risk is crucial for ensuring the financial health of your business. One of the best and most efficient ways to do that is through a credit risk rating system to help you make quick, sound lending decisions. If you don’t have a risk rating system or if it’s been a while since you updated it, here are some considerations to keep in mind.

Importance of risk ratings

A risk rating system is an essential tool in managing credit risk for your business. It is a scoring system that provides consistent guidelines for evaluating credit worthiness. Such a system will allow you to assess a company’s probability of default and help you make quick lending decisions.

A risk rating system helps you avoid credit policies that are too strict or too lenient, both of which can hurt your bottom line. Having a definitive credit scoring system can also help reduce conflicts between the sales and credit departments, as well as reduce overhead.

Factors used in rating risk

There are a lot of factors to consider when assigning a company’s risk rating. Here are some obvious ones as well as some you may not have thought about:

  • The borrower’s financial health. Research the borrower’s cash flow, liquidity, profitability ratio, credit scores, etc.
  • Quality of management. Consider things such as tenure and experience, as well as more subjective judgments such as reliability and relevance of the experience.
  • Trade references. Check with other companies they’ve done business with to discover any problems.
  • State of the industry. How well is the industry doing during current economic conditions: Cyclical industries may be more volatile. Industries with low barriers to entry may entail more risk.
  • Political and environmental conditions. Consider current political leaders’ policies, threats of war, and effects of pollution or climate change.

Putting your scorecard together

A risk scorecard brings all the borrower’s relevant information into one formula that determines a threshold of risk tolerance to help you make sound credit decisions. Credit professionals often don’t have a lot of time to look at spreadsheets and credit reports or to call references and perform all the other manual tasks in credit decisions. A risk scorecard can eliminate much of that time-consuming process and make decision-making more efficient, reducing overhead and freeing up staff for other key tasks. To get started, here are some best practices for creating your scorecard:

  • Get granular in your scoring. Split your ratings into smaller, more precise categories for more intelligent decision-making.
  • Use consistent rating results across lines of business, customer, and time.
  • Use clear, definitive data (objective data should be given more weight than subjective data).
  • Be transparent. Analysts should be able to determine how a rating was derived.
  • Use the latest technologies and platforms to store, analyze, and report the data.
  • Make your scoring system easy to use and provide clear instructions on its use.

Having a credit risk rating system is essential for efficient credit risk analysis. If your credit department has not created a rating system or an older one needs an update, MSCCM can help.

Need help managing your commercial credit risk? MSCCM financial experts can assist you. Contact us today.