05 Mar 2024
by Jules Eames FCICM (Grad); PGCE, Iain Young MCICM(Grad)

4 Steps to Effectively Mitigate Credit Risk 

Jenga Blocks

Our previous blog titled ‘Understanding Credit Risk’ set out the ‘why’ - what credit risk is, why it matters and the practical differences when applied in B2C and B2B environments.  

In this blog, we’ll expand on the ‘how’, and provide practical strategies you can apply to improve your risk control measures and safeguard your business from financial loss.  

We know that extending credit to customers can fuel sales and growth, but that it carries inherent risks of late and non-payment. If left unchecked, this can ultimately lead to the erosion of profit through bad debt losses. Our aim should be to retain the benefits that come from granting credit whilst having effective risk control procedures in place that act to minimise those potential downsides. Here are some tried and tested strategies to help you achieve just that: 

Identify and Assess: 

  • Know your risk appetite: Remain flexible, and adjust your approach based on economic conditions. It’s important that changes are communicated and everyone understands what is an acceptable level of customer risk. 

  • Use data: Conduct cohort analysis to test the effectiveness of your existing strategies and use a champion/challenger model to evaluate alternative approaches. 

  • Assess customer creditworthiness: This involves satisfying yourself that your customer has the capacity and character to pay you, in full and on time. Having a detailed credit application form is a good place to start, but you can also make use of credit agency reports, financial statements and a wide range of publicly available information.  

  • Assess macro factors: Don’t simply focus on the individual customer – consider the market risk too, as this can have a large bearing on your customer’s ability to pay. 

Communicate and Negotiate: 

  • Establish a credit policy: Clearly communicate risk thresholds, credit limits, and payment terms in your credit policy. Ensure this document is signed off by the senior leadership team and is made available to all staff. 

  • Negotiate effectively: Discuss payment terms with customers and involve necessary internal stakeholders. Consider forbearance options (B2C) and adjust terms based on customer performance and changing circumstances. 

Spread the Risk: 

  • Diversify your customer base: Avoid overexposure to a single customer or industry sector to minimise potential losses from insolvency events. 

  • Explore credit insurance: This financial tool can help protect your business from losses arising from customer non-payment. 

Sharpen Your Skills: 

  • Register for our "Best Practices in Assessing Credit Risk" workshop: Gain advanced knowledge and skills in managing credit risk effectively. 

  • Continuously monitor your customer base: Because nothing stays the same forever, it’s prudent to regularly review payment terms, check for adverse information and obtain updated credit reports on your existing customers. Insights gained can be used to adjust credit limits and payment terms to manage exposure. 

Managing credit risk isn’t an exact science; it’s a complex area, with lots of variables in play at any given time. Although it might sound ideal, the goal isn’t to completely eradicate bad losses because no system is perfect and taking an overly cautious approach means you won’t obtain the full benefit that extending credit brings. Instead, it’s about finding an acceptable balance of risk and reward that works for your business, and these strategies will provide a solid foundation to build on. 

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