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What is credit risk management?

Posted by Neha De

November 10, 2021    |     3-minute read (522 words)

A global pandemic and the resulting recession have affected every business in the world. Therefore, it is crucial for all businesses to increase their working capital in order to protect their company, now more than ever. 

Due to the pandemic — and even without a pandemic — there will always be customers who will not be able to pay up if you sell on credit terms. This is where knowing the nuances of credit risk management can help save your enterprise. 

Understanding credit risk management 

Credit risk management is the process of analyzing the risks associated with selling goods on credit. Essentially, it entails analyzing the buyer’s credibility to ensure timely payments. 

Credit risk management is important especially for small and medium-sized companies because, in most cases, these businesses are so focused on increasing sales that they do not always analyze their portfolio risk carefully. And, because of improper credit risk management, they experience delayed payments, which affects their working capital. 

Credit risk analysis is different for every organization. The challenges that a large enterprise faces is usually different from that of a mid-sized business. Often, established businesses have a dedicated credit risk analysis team that mines user data, studies customer credit reviews and also secures a bank guarantee before extending credit to customers. However, for small- and medium-sized businesses, getting access to credit rating sources, due to the time and cost attached, may pose a challenge. 

4 best practices for managing credit risk

Managing credit risk is important to any small business that wants to grow its financial strength. And to manage risk, the first thing is to know how to anticipate risk. Check out these four strategies your small business can take right away in order to manage credit risk: 

  1. Don’t focus only on new customers - Most business owners believe that long-term business relationships are stable and built on a foundation of trust. However, bad debt can come from old and new customers alike. Therefore, it is prudent to treat credit risk management as a continuous process. And all entrepreneurs must appraise the credit risk for their suppliers, vendors and customers on a regular basis, and keep an eye on trends in business credit profiles that indicate imminent trouble.  

  1. Trust technology - A manual credit risk review process may seem cheaper and something that can be done just by pulling in data from multiple reporting sources and examining it. However, this method may end up causing more harm than good as you may end up either missing or misunderstanding crucial information.

  2. Trust your team members - Sometimes, your people in sales, marketing, customer service and even the executive suite may come in useful while assessing your credit risk. For instance, a customer may let out to a salesperson that they are downsizing their office and may have problems with slow payments.

  3. Take fraud seriously - Most small businesses are anxious to build relationships with new vendors, suppliers, customers and other business partners, and may overlook signs that a business relationship may not serve their best interests. Hence, it is important to apply risk management practices to all work relationships.

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