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Financial and Credit Risks

Business Credit Risk Management

Increase Your Chances of Getting Paid on Time

Many suppliers and manufacturers sell goods on trade credit, invoicing customers for payment at a later date. Business credit risk management helps suppliers make lending decisions based upon the financial health of their customers. Extending the appropriate amount of credit to qualified buyers may reduce the risk of late payments or defaults, both of which can expose the vendor to financial challenges.

Trade credit is an important financing tool for small businesses that don’t meet the lending standards of traditional financial institutions. Even companies that qualify for bank loans may find trade credit terms to be more generous. There are potential benefits for suppliers too: Extending trade credit can help attract new customers or encourage them to buy more.

However, when vendors sell goods on trade credit, they’re essentially making an unsecured loan to the customer. It’s important that suppliers perform their due diligence to manage the risks that come with extending business credit.

Understanding a Business’s Risk Profile

Access to accurate business data is crucial when assessing credit risk. Suppliers often consult business credit bureaus or company databases to familiarize themselves with a new customer. Here are some of the indicators that can be used to understand the level of risk associated with extending credit to a business:

  1. Trade References: Vendors, banks, landlords, and other partners can report payment experiences to business credit bureaus. Trade references may highlight late payments or defaults on previous business debts and are valuable sources of information for suppliers to consider before extending trade credit.
  2. Public Financial Documents: A business’s quarterly earnings reports, investor guidance, and other documents can provide detailed information about the overall financial health of a company. Certain scenarios, such as frequent management changes or recently shuttered stores, can be signs of trouble.
  3. Industry Trends & Demographics: Statistical models compare a company’s performance to firms in the same industry or region. The use of predictive analytics can reveal whether a business is underperforming or presents a higher financial risk to lenders.
  4. Business Credit Scores & Ratings: Business credit bureaus consider many of the factors above when calculating a company’s credit scores and ratings. Consulting these scores and ratings allows businesses to minimize independent research and more quickly understand the risks associated with a firm.

Of course, trade references, financial documents, or business credit scores and ratings can also reveal encouraging information about a company. Either way, business owners should set credit limits based upon their confidence in a customer’s ability to pay.

How to Make Business Credit Decisions

At a minimum, vendors need answers to two main questions before extending credit to another business:

  1. How likely is the business to default on a loan? This speaks to the overall financial stability and credibility of a company. If a business’s risk profile indicates that it’s financially stressed, you may not want to extend trade credit for fear of taking on a bad business debt. Businesses that seem to be on a sound financial footing may be better candidates.
  2. How much trade credit should you extend? Even profitable businesses face upper limits on what they can afford to borrow. Once a decision has been made to extend funds, the lender needs to determine a reasonable credit limit and repayment schedule. Both aspects must align with the borrower’s ability to pay.

    Suppliers take a variety of approaches when setting trade credit limits. The dollar amount can be based upon a percentage of a borrower’s net worth, or the vendor may simply match what other businesses have lent and recouped.

Business Credit Management Solutions

There are a multitude of resources that can help companies manage business credit risk. We’ve already mentioned business credit bureaus and company databases, both of which can provide easy access to in-depth data. Many of these providers, such as Dun & Bradstreet, allow businesses to review information through a variety of products.

Business credit reports can often be purchased a la carte or as part of a subscription. Certain applications assist businesses in setting credit limits. Additionally, some credit monitoring solutions alert companies to changes in a customer’s business credit scores and ratings.

Business credit risk management is essential for making sound lending decisions and protecting cash flow. While it’s impossible to eliminate all risk, the wealth of data available to businesses can help them guard against outstanding debts and defaults. 

Dun & Bradstreet provides business credit scores, ratings, and research to help companies manage credit risk.

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