Implementing an effective credit risk management process

credit risk

Small businesses benefit greatly from being able to do more business with the right customers. One way to do this efficiently and confidently is by implementing a clear and consistent credit risk management process.

An effective, well-designed credit risk management process will save your small business time, help you deliver a better customer experience, increase employee satisfaction, support compliance with government regulations, protect your assets and help secure your cashflow.

Limited in your resources in terms of budget or manpower? You can still make the process effective through the help of technology, like accounting software add-ons that streamline credit management processes. 

Let’s look at the various factors shaping this process.

It’s important to understand what credit risk actually is, to effectively manage it. Credit risk is the potential for a borrower to default on their debt obligations, which results in a loss for a lender or creditor. This could mean non-payment from a customer, supplier, or partner, which would result in a financial loss for the business.

Taking on losses from a defaulted debtor can pose a significant challenge to small businesses, as you’re typically less likely to have the resources to absorb such losses compared to larger firms.

Credit risk is usually assessed by analysing a borrower’s creditworthiness, or their ability and willingness to repay their debt obligations. It is determined by evaluating the borrower’s credit history, income, debt-to-income ratio, assets, and collateral.

What does an ideal credit risk management process look like?

The process can be based on each step a customer takes while making a purchase. From the information they must provide to become a customer, to the ongoing monitoring of the business, to the steps you take to collect payment for goods or services rendered. That journey can be grouped into three different customer relationship stages: onboarding, account management and receivables.

Onboarding a customer starts with a thorough credit risk assessment, where a business gathers all the information required for due diligence such as credit assessments, and director and banking details. If deemed credit-worthy, both parties can then set the tone for their relationship, implementing credit terms that work for both.

Automation of the onboarding process removes manual processing of documents, reduces human error, speeds up the process and allows you to trade with your new customers much more quickly.

Once a customer is onboarded, you must ensure you manage your risk exposure to that business over time. This step, which can also involve sales and marketing teams, is called account management. Having a proactive credit risk management process can help your business set itself apart from the competition as it helps you remain aware of real-time changes in a customer’s creditworthiness or risk of default.

Automating this process also helps. With online tools, you can set real-time alerts, so you are automatically notified of any adverse changes to customer details, enabling adjustment of risk exposures.

The final step, accounts receivable, should be straightforward – job completed, invoice sent, and payment received – but several factors mean it’s often not. Robust credit risk management can help make this step easier and ensure payment is collected in a timelier manner through automation. Your business can also prioritise debtors based on real-time debtor risk and trade payment insights.

The fewer manual accounts receivable processes your business has, the more effective your credit risk management process is. Look to systems that bring together all required financial information – customer credit rating, director information and payment history in one place – to remove any unnecessary administrative burden.