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“Credit risk: the possibility that one of the parties to a contract does not honour its financial obligations, causing a loss for the creditor counterparty. It was 2001 when economist Manuel Ammann chose these words to define one of the most decisive aspects of economic-financial relations and, more banally, of any transaction involving a loan of money.
Knowledge of this variable has great importance in the management of the business: thanks to it one can in fact avoid risks (among all: a liquidity crisis) that could prove particularly damaging to the company, strategic decisions can be taken and decisive choices can be made for the company’s destiny.
However, the concept of “credit risk” does not end with Ammann’s definition. In the extreme case of credit risk, it is defined as total and conscious insolvency on the part of the debtor. In reality, however, it can take on several facets, none of which are completely free of any pitfalls for the creditor. In fact, there is the case that a debtor is the victim of a deterioration in the financial situation of the market. If he gets into difficulties, he may not be able to fulfil his obligations not out of will, but out of sheer impossibility. This hypothesis broadens the concept of credit risk, which can therefore be defined, more generally, as the possibility that an unexpected change in the creditworthiness of a debtor results in an unexpected change in the credit value.
The importance of knowing the credit risk
The reliability of the customer has a decisive influence on the health of the business. A customer who is constantly in arrears with payments, whether insolvent or problematic, can have major consequences for the liquidity status of the company. Incoming and outgoing flows, squeezed between debtors and invoices to be paid, can be affected to the extent that the ability to meet all bank payments is compromised. The liquidity crisis, in this sense, represents one of the most concrete risks for small and medium-sized enterprises. It is openly conditioned by the credit risk generated by the client portfolio, which is why, especially in the current context of particularly severe credit transfers, it is essential to know, manage and work on this risk in order to prevent the most damaging consequences.
But how? A good business strategy must include a range of activities in this area. For example, it is essential:
- monitoring the portfolio risk on a daily basis and constantly, defining the lines of a serious credit policy;
- monitoring overdue receivables and credit seniority;
- checking creditors’ payment methods and habits;
- study the composition of the customer portfolio on the basis of customers’ solvency capabilities;
- monitor accrued delays;
- constantly define collection targets.
Keeping all these factors under control, especially from a forecasting point of view, will have a positive effect not only on the health of the company, but also on its ability to access bank receivables.
How do you know if a customer is “healthy”?
Given all these best practices, how do you know if the given client is in good financial health? How do you access data on your credit risk, preventing rather than remedying any damage? The procedure is called credit management and is nothing more than a process aimed, thanks to certain tools, at determining risks in a predictive way.
One solution may be to develop internally, on the basis of the data present in the company, tools capable of giving an opinion on the reliability of the subject. In-house” practices, based on little and essential information, can in fact constitute a first bulwark against credit risks.
Another solution is to use specific tools, of external origin, capable of carrying out in-depth analyses on the solvency of customers. There are consultants able to offer precisely this type of service to companies: information providers who can develop scoring systems, on the basis of which they can assign scores to customers based on the degree of risk. These services are constantly updated, whose evaluations may vary according to events, based on information arriving in real time.
Last but not least, one of the most innovative solutions. Access to information on credit risk is now also possible by operating directly from your own management system. The formula, original and very recent, in fact, allows you to obtain directly, via dashboard, all the information on the financial health of the client in question. For a financial director or entrepreneur the possibility is precious, because integrating this information in the context of business activities means having the possibility to manage their business with greater agility. And above all, with more awareness in the face of the unknowns of a clientele that may not be entirely reliable. It goes without saying that, in a framework of this kind, Data Quality and Big Data assume a fundamental role and can no longer represent optional choices in the management context.