It is normal for businesses to extend credit to customers. What is credit risk? How does one know how much credit to extend and to whom? This is important because every financial decision has an element of risk. The question here is, who should I extend to and how much credit should I extend, will I get back the money and if so whether I will get it in time? Delays and defaults by debtors always effects the cash flow of businesses and consequently the business cycle effecting profits. Credit risk, is when the borrower does not make payments as promised. However extending credit prudently is one of the important ways of building business. Are you facing problems? Here are a few credit risk management and credit risk analysis tips.
New entrepreneurs should be extremely cautious in extending credit to customers. You may perhaps think that you can take over customers from your competitors, but actually it may be possible that you are extending credit to customers who have already defaulted payment to them. Make a thorough check of the customers business and his financial history. A number of reputed credit risk rating companies will be able to offer you with reliable information for a small fee. A safe bet would be to request for a bank guarantee or a letter of credit from their bankers. This will enable you to fall back on the banks for recovery of money, in the event of default.
According to D&B estimates, frauds costs businesses billions of dollars every year.
Businesses should be careful of new customers, who are willing to abide by all the terms and conditions imposed for getting goods / services on credit, without any discussions, provide high profile references which are difficult verify and claim to be in business for a long time, particularly if you have not heard of them before.
It is important for businesses to monitor the accounts of existing customers regularly. A major portion of defaults occur in the accounts of existing customers. Look for early warning signals in your customers dealings. Some of the warning signals could be, delay in payments in recent times, frequent request for extending time for payment. Lawsuits or judgments against them, change in address or ownership etc. These signals should prompt you to make further investigations to satisfy yourself that they are still a good credit risk. If there is any doubt in your mind it is better to stop further credits and concentrate on recovering existing debts. It is better to lose a customer rather than a business.
Many businesses feel that sales is the driving force of a business. While sales is important, collections are equally, if not more important for the growth and development of business. It will be worthwhile to monitor the debtors accounts regularly and meticulously for the purpose of identifying signs of distress and for recovering payments. With the use of more and more of technology it would make sense to invest in technology to take care of your accounting and follow-up of debtors accounts.
Many businesses today face problems as there is an increase in frauds worldwide. So you have to be very careful before you close a deal with your customer. Clearly explain the rules and regulations of payment procedure, time limit, etc. Print the rules and give a sheet to your customers. Keep checking with your customers regularly after they place an order, when would they make the payment, how would they make it, etc. Do not deliver the entire order if its a big deal, keep sending the material as you keep receiving the payment.