Managing credit, ensuring optimum cash flow, and limiting chances of defaulting on payments has always been a top priority for businesses. The last few years have seen several businesses take credit risk management seriously as a process that can help ensure viability and sustainability.
According to leading financial experts, businesses of all shapes and sizes work on credit. It refers to the process of invoicing payments for a later date. This means that the vendor, customer, or supplier who has promised to make the payment should not default.
Credit Risk Management allows businesses the ability to assess the financial feasibility of their cash flows. Any time that you start working with a new supplier, they will check out your creditworthiness at certified bureaus and try to learn more about your payment history.
In this article, we are going to look at five effective ways companies should manage their credit risks in 2022. However, before we get to the list of ways and strategies, let us first look to understand what credit risk management is all about.
- 1 Credit Risk Management: Meaning and Definition
- 2 List of 5 Ways Companies should manage their Credit Risks in 2022
- 2.1 1. Using Advanced Software Tools and Technologies-
- 2.2 2. Doing Prior Research with Credit Bureaus and Industry References-
- 2.3 3. Establishing a Credit Ceiling to Minimize Risks-
- 2.4 4. Carry out a simple Google Search about the Business-
- 2.5 5. Engage with Constant and Close Monitoring of the Credit Risks-
- 3 The Bottom Line
Credit Risk Management: Meaning and Definition
Traditionally, credit risk management as a concept was associated with the practice of lending by banks. It has been related to a bank assessing the borrower’s ability to pay back the borrowed sum (loan) and make monthly payments.
Ever since then, the term has evolved and found application in business ecosystems as well. Businesses work with multiple vendors, sellers, customers, suppliers, and more. The entire cycle right from production to final sale is run and dependent on credit extension.
Let us try to explain this with the help of an example-
Suppose you are a showroom owner that sells furniture and other utilities. You place an order for 50 chairs from a furniture company. You do not make any upfront payment and say that you will make payments after a month’s lapse.
The chair-making company extends the 50 chairs to you and gives you a credit of one month to make the payment. The chair-making company asks the raw material supplier (let us assume they are plastic chairs) to help them with chemicals that can help them make them.
They promise to repay the raw material purchase amount after a period of one month. The raw material supplier agrees and gives the same to the chair-making company at a credit of one month.
This is the cycle of credit. Failure to repay at one point triggers a flash reaction that affects everyone on the cycle. Following the COVID-19 Pandemic, there were several problems as business entities started defaulting on their payments.
List of 5 Ways Companies should manage their Credit Risks in 2022
1. Using Advanced Software Tools and Technologies-
Leading businesses use specialized tools and software like the Credit management suite by SOA People to manage risks. This software easily integrates with a businesses’ SAP systems and allows them to evaluate risks at different points in the financial cycle. This allows for taking important financial decisions and reducing exposure to bad debts for the business.
2. Doing Prior Research with Credit Bureaus and Industry References-
Before you sign an agreement with any new business entity, it would be worthwhile that you to try to understand more about them. One simple way to assess their creditworthiness would be to contact the Credit Bureau and find out more about their risk status. You can also reach out to their past vendors and suppliers and check out more about their payment history and records.
3. Establishing a Credit Ceiling to Minimize Risks-
If you are a business owner, you know that credit gets recycled. You always end up paying or getting paid for the last order and never the present one. While this is normal, one thing that businesses should focus on is fixing a credit ceiling. This means that beyond a certain limit, you will stop extending credit unless prior payments are cleared.
4. Carry out a simple Google Search about the Business-
Sometimes the most elementary things are the ones that we miss. Something as simple as a Google search about the business can reveal good or bad news, depending on what the business has been up to. If you see that the business has won awards and is doing well, there is no reason to get worried about your credit risk. If you find something negative, it is best to stay away.
5. Engage with Constant and Close Monitoring of the Credit Risks-
Your work on assessing the credit risk should not stop after extending it. In fact, you should always be on your toes so that you are always aware of any dangers and challenges that might come your way. Make sure that you follow up on payment details on the agreed dates, try to get part payments as and when you get a chance. All this will help you limit the credit risks.
The Bottom Line
- If you are not seriously engaging with Credit Risk Management, you are exposing your business to severe financial perils. This can hurt your cash flows, limit your ability to grow and diversify, as well as reduce your financial reputation in the eyes of others. If you have any questions, you would like us to address the subject, please let us know in the comments below.