Businesses that offer goods or services on credit, face the risk that some clients may ultimately not pay up. This could result in significant financial losses and even financial ruin. Like all risks however it can be mitigated with appropriate policies and procedures so that negative impacts are minimised.
You can’t expect to get credit from a bank without undergoing rigorous financial and credit checks.
Likewise, a business can reduce the financial risk of extending credit by requiring all clients to apply for credit and by refusing to trade on credit with those clients who have doubtful means to pay their bills.
But how can a business determine which clients are of sufficient financial means and which should be avoided?
Credit Checking Processes
For your credit checking process to adequately mitigate your risk, it should include a number of key components:
It is important to start the process with all the key information at your fingertips. Although some specific investigations may differ from client to client, certain basic details should be collected from all applicants in an organised format. The best way to do this is with a standardised credit application form. Maintaining accurate records of each client’s contact details including billing and registered addresses is also important if debts must be recovered down the track.
Policies for approving credit applications
Consultation between your various departments may be beneficial to develop policies for approving credit applications and setting appropriate credit limits. Sales executives can provide insights on market realities and minimum credit limits required to facilitate business. While risk management and accounting disciplines are more familiar with what level of risk is acceptable for the business to take on.
The financial risk posed by a specific client may be assessed based on financial data contained in:
- credit reports
- credit references supplied by the client
- letters of credit
- financial statements and balance sheets, and
- personal credit reports on the CEO (where relevant).
Such data will generally provide a good picture of how a company is performing.
Credit assessors should also be trained to recognise red flags which may include:
- existing liens or charges on company assets
- seasonal fluctuations in the client’s industry
- existing commitments to trade credit relationships, or
- unusual price cutting or discounting strategies which may hinder its ability to pay on time.
As customers and industries change, so will risk profiles. As such, regular reviews of your credit checking processes and assessment criteria are recommended. Some businesses opt for a policy of regular ongoing financial disclosures from all approved clients to ensure they still meet approval criteria. Alternatively you may require such disclosures only upon the occurrence of certain events that trigger increased risk.
Utilising good credit checking procedures will go a long way to minimise bad debt, maximise income and optimise efficiency. If you’d like to implement better credit checking procedures and enhance your financial risk management talk to us about how we can help.