How To Assess Business Credit Risk
One of the main tasks of your credit manager or controller is to prevent losses through bad debts. Here we shall investigate the steps you can take to minimise your risk. It is one thing to grant credit, but to do so without any idea whether you will be paid is foolhardy. Of course no matter how stringent your credit vetting procedures are, you can only reduce the problem, never eliminate it.
Will Your Customers Pay?
To exploit the market fully and attain an acceptable level of profit you must be prepared to embrace a level of commercial risk. Spotting those customers who are secure, and those you should only trade with on a COD basis, is easy. It is the large numbers of potential customers between these extremes who will be your source of growth, providing they are properly evaluated. It is here credit management comes into its own, co-operating with sales, and adjusting terms to avoid overstretching the resources of your weaker customers, thus ensuring sales and collection targets are met while at the same time preventing late or non-payment.
Avoiding internal conflict
Responsibility for risk evaluation ought to rest with the person nominated to operate your credit policy. This person should be given ample internal and/or external training to accomplish this important task. If you employ a credit manager or a part-time controller it will be their responsibility, for it will be they who will be accountable for collection, and for bad debts arising from poor assessment. Sales reps and their managers are judged on the volume of sales made irrespective of whether payment is received or not. So it would not be fair to ask someone to reject a potential order with a firm which may have a doubtful credit history, when his or her livelihood depends on taking as many orders as possible. Nevertheless, the credit manager must involve the sales department in his deliberations for he has a duty to his company to:
- accept any likely profitable order
- balance risk against profits
- decide when to commence his collection procedures
Starting the vetting process
Once a potential new customer either approaches your firm or is contacted by your sales team, the credit risk process must commence. Prompt action will prevent the first business transaction from being delayed. So what does a credit manager require from the sales team to commence his assessment? He needs the following:
- full name and address of customer
- value of the initial order
- name and address of bankers
- trading status of firm
- copy of trading accounts.
With this knowledge to hand the credit manager can begin the investigations which will help him to form a valid opinion.
Using New Account Forms
The best method for obtaining this information is to use a new account application form for trade credit. Unfortunately, most sales reps have a distaste for form filling, unless it is an order form. So it is essential you explain the reason for its use, so they understand it is not a means to deter orders but to encourage profitable business dealings with a new customer. When first introducing this document the sales team must be made aware what the questionnaire will do for them, such as:
- rejecting fewer orders
- quicker turn-round in accepting new business
- secure and more profitable trading
An aid to collections
It should quickly become second nature for a sales rep to complete a new account application form. To avoid mistakes the form should be completed by the customer personally: naturally the sales rep will need to check the details are correct before leaving the customer’s premises. The form must be completed in full, and signed by an authorised signatory within the customer’s organisation. So in addition to identifying the trader, and providing details of bankers etc, the form is likely to provide the credit manager with contacts which will be important to him or her when the collection process gets under way, including:
- names of director or partners
- the name of the person who will be approving the account for payment
- invoice and/or registered office address if different.
The signed form indicates the potential customer’s willingness to accept and abide by your terms of trade.
Anna work for Global Tax Reclaim and writes the content for their websites and blog.