Managing credit risk is essential for cash flow, and cash flow is essential for a reseller’s survival.
What is credit risk? It’s the probability of financial loss. Every customer and every transaction will pose a certain level of credit risk. They might not pay you at all. Or they might pay you, but it will be beyond your trading terms and the money will come in months after it was due.
Good credit risk assessment is the best way to handle non-payment and late payment. For a start, the reseller has to get the basics down: registered name and trading name of the client, their ABN number, the type of entity, the registered address and primary business address, any trade references and, if the applicant is a sole trader, the date of birth or driver’s licence number.
The reseller can also turn to accredited credit reporting agencies, like the ATO and ASIC. These entities are equipped to verify the registered name, registered address, ABN number, type of entity and date of incorporation or the date the business started.
When all that is done, the reseller should look at the financial data. That includes growth in turnover, profitability, gearing and the asset base. All these are good indicators of financial strength and can be measured using financial ratios.
Then there is personal financial information. If accurate, it provides an assessment of an individual’s financial strength. This sort of information can be gathered from a personal assets and liabilities statement. It’s also important to consider other assets such as real estate. All these can be easily verified; it’s all on the record.
And there are credit reporting agencies. Their job is to provide access to land titles, other assets and encumbrances such as mortgages.
There are ways to assess high-risk and low-risk applicants. Low-risk applicants have been in business a long time. They tend to have a large number of staff and many years of business experience of individuals or management. High-risk applicants have directors that are linked to failed companies. Their businesses might also be facing court actions or default notices.
Resellers can also use credit scoring software that comprise scorecard packages and decision engines that determine whether credit should be provided. There are limitations, and it should be used carefully. Because it is software, it doesn’t take into account personal circumstances, for example, an injury or problems that suddenly came up with the business.
Nonetheless, credit scoring assigns a numerical value to measure the risk. The credit score is always based on benchmarks and historical data. The reseller gets a result usually presented as an overall risk percentage. The credit scoring process makes the assessing of information less subjective. That, at least theoretically, allows a business to make consistent and informed credit risk decisions.
In cases where the credit risk is elevated, it does not necessarily mean turning away the customer. There are strategies to keep doing business, including obtaining personal guarantees, and reducing credit limits and trading terms. Credit risks should not stop a business from transacting with a customer.
Every reseller has to determine what level of risk they are able to bear. But the decision also has to be done in a way that does not restrict their customer base, trade or reduce their income.
Leon Gettler is a senior business journalist who writes for a range of newspapers and journals.