Any time you give a client a good or service and then invoice them for payment, you run the risk of not getting paid. A successful credit risk management strategy is essential for your company’s growth.
What Exactly Does “Business Credit Risk” Mean?
When you bill customers after delivering goods or rendering services, you run the risk of getting paid late or not at all. Your cash flow may be hampered, and your profit may drop. Credit extension does not always involve taking a risk. By doing this, you can persuade a customer to spend more money with you or set yourself apart from rival businesses who don’t accept credit. However, you should only grant credit after thoroughly determining a potential client’s creditworthiness.
Businesses that are relatively young, have little or no credit history, or have bad credit ratings are all regarded as high risk. Additionally, some industries are seen as having a high danger of going bankrupt. For the most recent analysis of credit risks by industry, see our Sector Risk page.
What Kinds of Credit Risk Are There?
Credit risk typically falls into one of three categories:
Credit default risk is the possibility that a customer won’t pay your invoice. You assume a credit default risk whenever you deliver goods or services and then invoice for them.
Extending a big amount of credit to one major client or a group of clients whose invoices account for a sizable portion of your revenue is known as a concentration risk. You run the danger of suffering losses with a high concentration risk, which could have a big effect on your cash flow.
The exposure your company faces while conducting business abroad is referred to as country risk. Currency exchange rate fluctuations, political unrest, economic instability, the possibility of trade embargoes, and other factors can all have an impact on a nation’s credit risks. All of these elements play a significant role in managing foreign credit risk and have the potential to severely affect the business environment and cash flow into and out of the nation in which you conduct business.
What variables are used while evaluating credit risk?
Before working with a new client, you should be sure that they have the financial stability to make all of their payments on schedule. There are many significant credit risk elements to take into account when determining a client’s or potential client’s credit risk.
Financial stability and adaptability: Companies that have good finances, sufficient capital, and a track record of being able to generate money when necessary are typically lower risk. A higher-risk client may become concerned if there are indications of stress in a company’s historical (especially recent) financial performance, such as cash flow problems, slow sales growth, declining revenues, closed locations, delayed payments, and issues financing capital.
Payment history: Based on a client’s payment history and public information, you can determine their capacity to pay payments by running a business credit report. Insights into how low- or high-risk a client may be for non-payments are provided by financial information such annual sales, invoice activity and credit limits over multiple years, legal judgements and collections actions, and a business credit score, which are all included in the report.
Business diversity and stability: Investigating a client’s or potential client’s revenue stability, liquidity, debt-to-equity ratio, profit margins, and return on investments (ROIs) can reveal crucial information regarding the client’s stability and propensity to make payments on time. A company may be more equipped to withstand variations if it has a broad revenue stream, client base, geographic location, and industry categorization.
Risky associated with the industry: A potential client who faces large industrial risks is also more likely to have a higher credit risk. Regulations and laws that are specific to the industry, economic trends and volatility that affect that industry, the amount of industry competition, the industry’s growth rate, and the industry’s significance to the economy’s overall growth are all key factors to take into account.
Country dangers: An essential factor in determining the credit risk of an overseas client is the country’s specific economic, political, and business risks, which could cause unanticipated investment losses.
Business news: Researching a potential customer might reveal valuable information about stability and risk. It is more likely that a company will be stable and low risk if it is winning awards, expanding into new markets, adding more employees, getting plenty of favourable customer evaluations, and being the topic of other positive press. The business is probably a risky investment if there are inquiries, bad reviews or news articles, layoffs and closures, and other negative news is being publicised.