If you are serious about your long-term success, it is more important than ever to have a thorough approach to credit risk management. Banks have been doing it for decades, businesses need to follow suit. Banks make sounds decisions about lending based on credit risk assessment and management tools, which safeguards their business.
What is credit risk?
To begin managing your businesses credit risk, you first must understand what it is. Credit risk refers to the probability of loss due to a borrower’s failure to make payments on any type of debt. When a borrower fails to pay any type of debt, your business loses revenue. Credit risk has gone from being a necessary business evil to a strategic survival imperative.
Credit risk management on the other hand is the practice of mitigating those losses by understanding the adequacy of a borrower’s capital and loan loss reserves. This is a process that has long been a challenge for financial institutions but is increasingly important. Failure to adequately mitigate your credit risks could severely impact your business.
Why you need to manage your risk
The financial crisis of 2008 highlighted that no business is safe and even if your business is safeguarded if a risky business is connected to yours, its collapse could well lead to the downfall of your operation.
Businesses are facing increasingly strict legislation and heightened requirements for good governance, risk management and accountability. In the decade since the financial crisis, credit risk has gone from being a brushed off part of doing business to a strategic sustainability measure.
Benefits of credit risk management
The major benefit of integrated, quantitative credit risk management is to reduce revenue losses. Monitoring your credit risk allows your executive management team to understand which potential clients may come at too high a risk and above your pre-identified risk tolerance.
Credit risk, if correctly identified and managed, can be leveraged as a strategic opportunity. Through effective credit risk management your business is able to greatly improve overall performance and secure a competitive advantage. This was demonstrated by South African banks being less affected by the global financial crisis than their international counterparts. This was due to rigorous and highly effective credit risk identification, assessment and management.
How to manage your credit risk
The very first step for businesses is to accurately identify and quantify such risk. When you get a grasp of your credit risks, these should be managed as an integral part of your business.
Here are a few basic steps to follow:
- Check potential customers credit scores
Credit scores are a powerful indication of the risk your potential customers pose. Checking a credit score will help your business evaluate your credit and supplier risk, increase collections, and reduce fraud. Your ability to make the right decisions is only as good as the data driving those decisions, so be sure to get current, comprehensive information.
- Draft your credit lending terms
When generating sales, it is important that your agreement with your customers include a clear and comprehensive terms of credit. This will minimize the risk of disputes and improve your chances of getting paid in full and on time.
- Build good customer relationships
One of the easiest ways to manage your credit risks is building a long-term, trusted relationship with your customers. Discuss your credit terms before extending credit and get a sense of their attitudes towards credit. It is essential that you make it absolutely clear what your terms are and what you expect of your customers.
- Develop a standard process for overdue accounts
You need to have a standard policy as to how your business will safeguard itself against non-payment. Your chances of collection are highest within the first 90 days of an overdue account, so if you have a standard process you can begin collection as soon as you notice an error.
In today’s economic realities, effective risk management is imperative to your business’s long-term sustainability and growth. MarisIT provides credit scoring and vetting solutions for small, medium and enterprise companies. Our expertise in providing fully integrated credit bureaus and real-time technology solutions enable our clients to maximise their profit, minimise risk and grow their businesses profitably by eliminating bad debt and fraud. Find out how to effectively manage your business’s credit risk today.