Any time you provide a product or service to a client and later invoice them for payment, you undertake a risk that you won’t be paid. Effective credit risk management is imperative to the success of your business.
What is Meant by Credit Risk?
When you invoice clients at a later date after providing goods or services, you take a risk that the client will not pay on time or default on payment. This can disrupt your cash flow and reduce your profit.
Taking a risk by extending credit is not necessarily a bad thing. By doing so, you can encourage a client to spend more with your company or stand apart from competitors who don’t offer credit. But you should extend credit only when you have effectively assessed a potential client’s creditworthiness.
Businesses that are considered high-risk include those that are relatively new, those that have no credit history or those that have poor credit ratings. In addition, certain industries are considered high-risk for financial failure. Visit our page to get up-to-date analysis of credit risks by industry.
What Are the Different Types of Credit Risk?
Typically, credit risk falls into three categories:
- Credit default risk refers to the chance that a client will not pay your invoice. Any time you provide goods or services and invoice for them later, you undertake a credit default risk.
- Concentration risk refers to extending a high amount of credit to one large client or to a group of clients whose invoices represent a significant part of your revenue. A high concentration risk exposes you to losses that could significantly impact your cash flow.
- Country risk refers to the exposure your business takes when doing business internationally. Country-specific credit risks are affected by fluctuations in currency exchange rates, economic or political instability, the potential for trade sanctions or embargo, or other issues. These are all factors that can negatively impact the business environment and cash flow in and out of the country where you do business.
What is Credit Risk Management?
Business credit risk management is the actionable plan you use to guard against late payments or defaults. It helps protect your business’s cash flow and improves performance. Business credit risk management is a continuous process of identifying risks, evaluating their potential for loss and strategically guarding against the risks of extending credit. Because credit risk management is proactive, it helps reduce the possibility of a default and its impact on your organization.
Best Practices for Credit Risk Management
Effective credit risk management practices differ from business to business. Experts agree the following general best practices can successfully guide any business in managing credit risk. They include identifying the risk of a new client defaulting on payment, analyzing the risk and creating a proactive plan to mitigate credit risk.
Identify the Risk
You can identify the potential for credit risk of a potential new client by reviewing data about the company from the local Chamber of Commerce, credit bureaus, bank and trade data and the company 10k. This data can help you better understand your potential client’s creditworthiness and help you decide if you should extend credit and with what terms.
Euler Hermes can help. We offer a about sector and country risks that can help inform your decisions about extending credit. In addition, we can leverage our credit-risk grading model to help you forecast credit risks and potential customer defaults.
Analyze the Risk
Whenever you consider extending credit to a client, you must analyze two things: the client’s creditworthiness and the potential impact on your cash flow should the client default. By doing so, you develop an important structure for credit decision-making.
Euler Hermes is uniquely positioned to support clients’ credit risk management and credit risk analysis requirements. Our SmartView platform is a risk-monitoring service that gives Euler Hermes customers immediate visibility over trade receivables and a better grip on risk and opportunity management. You gain valuable insight on the financial health of your customers via a wide range of risk reports. Plus, you can also keep track of your customer’s creditworthiness and capture growth opportunities.
Create a Proactive Plan
Good credit risk management requires a plan that will help you evaluate and extend credit for all clients. First, determine the credit terms – the amount of credit you are willing to extend and for how long. Discuss these terms with new clients before you extend credit. Then, conduct monthly or quarterly reviews of your accounts receivables to maintain a clear picture of your risk.
Euler Hermes can help in the decision-making process around tough high-risk credit decisions, including credit insurance that can help protect high volume/low margin accounts. In addition, the Euler Hermes support strategic decisions on higher-risk domestic and export market clients while maintaining sound financial management.