The pitfalls and red flags of bad credit management
14 March 2012
Recent news reports have shown a long list of companies entering external administration and having issues with bad debt. The increasing number of organisations finding themselves in trouble indicates a greater need for companies to pay closer attention to credit risk management. Veda, Australasia's leading provider of commercial and consumer data intelligence and insights, advises that stringent credit management is key to keeping a business healthy.
Veda's Business Credit Demand Index for the December 2011 quarter showed that mainly small and medium sized businesses (SMBs) are suffering from a high default rate with more than a quarter (26%) of defaults. But what's behind the story of so many struggling businesses is not always clear. "Before signing up new creditors, most businesses should perform a thorough check on the company and its Director(s) to evaluate their risk exposure," explains Moses Samaha, Head of Commercial Risk at Veda. By better understanding credit and fraud risk at the point of application, this can reduce the incidence of bad debt write offs and ultimately improve the bottom line. But according to Moses "Good credit management doesn't stop there. Businesses should also continue to monitor their credit portfolio to limit exposure to risk from late payment and external administration."
Veda statistics show that by looking at the people behind a business and any related entities they belong to, future losses can be substantially reduced. A company is four times more likely to find itself in a troublesome situation in the next 12 months if one of its directors has had adverse information on their credit file. An analysis of a company's credit enquiry activity provides a good insight into their credit demand and is also a leading indicator of risk stability. On top of that, businesses should continue to monitor their credit portfolio to limit exposure to risk of late payment or from external administration.
Veda has a number of easy tips that businesses should keep in mind; Veda's 5 C's of credit can be used as a guide in assessing the credit risk of potential creditors. The 5 C's stand for: character, capacity, capital, cashflow and conditions.
- Character: Research the people behind the organisation you are dealing with. It's important to assess a person's willingness to pay, based on their overall attitude, their company values and the financial track record of the business and its leaders. Check for any signs of a dark financial past. Factors such as past defaults or court actions can give important insight into the financial and ethical standards behind the people running the business.
- Capacity: Assessing the prospective organisation's capacity to generate sufficient cash flow to cover any outstanding debts should be the highest priority of any credit manager. This is critical before investing in a company or extending a large amount of credit.
- Capital: Understand your customer's capital base, including their cash and other assets, as well as shareholder commitments. This is important to ensure credit has not been extended to an organisation that can't afford to repay their debt.
- Cash Flow: Cash flow is the "lifeblood" of any business. Poor creditcontrol will greatly affect cash flow and the ability to pay debts on time, so it pays to develop an understanding of the financial situation of the business to which you are extending credit. This will give you an indication of how swiftly they may pay you for your products or services and the likely impact on your company finances.
- Conditions: The current economic conditions in each marketplace may affect the ability of a business to repay debton time, which may require adjustment of your credit policies. Consider factors such as the impact of international economic conditions on the domestic market, such as offshore financial volatility and fluctuating exchange rates, as well any changes in the political landscape. Is the prospective customer susceptible to economic downturns?
Veda can help businesses better understand the people behind the organisation they are giving credit to. The company offers tools to proactively monitor behaviour of a customer's portfolio and send through triggers and alerts on real-time basis.
© 2012 Veda Advantage
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