Proactive credit risk management up-to-date thanks to real-time information

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Financially sound for companies means knowing how to deal with financial risks. Credit managers are indispensable in this respect. They provide insights into debtor risks that are essential for informed credit decisions. This article highlights different forms of debtor risk and the importance of proactive risk management.

Allianz Trade's own research shows that Days Sales Outstanding (DSO), the number of days invoices remain outstanding, reached 59 days by 2023. Many companies express concern about the payment behaviour of debtors. Financial institutions are also seeing customers in arrears. As invoices remain outstanding for longer, liquidity comes under pressure at many companies. With the knock-on effect that these companies in turn start paying their suppliers later. It disrupts day-to-day business, it leads to higher costs (collection, interest) and, in the worst case, companies collapse due to working capital shortages. For companies, this trend should be an alarm bell. Is the accounts receivable policy in order?

Roughly speaking, three types of debtor risk can be distinguished: 

  • Payment risk: the probability that a customer does not pay the invoice. 
  • Concentration risk: providing high credit to one large customer or a select group of customers representing a significant proportion of sales. High concentration risk makes companies vulnerable because the loss of one customer has an immediate and large impact.
  • Country risk: the risk companies face when doing business internationally. Country-specific debtor risk is affected by fluctuations in exchange rates, economic or political instability, the likelihood of trade sanctions or embargoes, or other issues.

The Credit Manager plays a key role in minimising debtor risks and protecting a company's cash flow and working capital. For example, through effective credit analysis, monitoring, collection procedures and sound risk management.  A healthy debtor base is crucial for a company's financial stability and operational efficiency. By taking a proactive approach to credit management, using technology and maintaining good customer relationships, the Credit Manager contributes to the company's overall financial stability and growth.

Determining a sound risk profile of a customer or prospect requires a systematic approach that integrates both quantitative and qualitative data. Many factors come into play. Apart from the customer's financial health, industry-specific information is also crucial. What are risks inherent in the debtor's field, such as economic cycles, competition and regulations? In addition, the track record of the management team comes into play. Is the incumbent management capable of running the company effectively? Geopolitical developments should also be closely monitored. Look at how a war in Ukraine or a conflict in Gaza has far-reaching implications for global trade.    

In this broad area of focus, the primary focus is on the financial health and creditworthiness of the debtor. Traditionally, Credit Managers relied heavily on historical financial ratios. Analysis of (financial) data has gained unprecedented momentum over the past decade. With AI, huge amounts of data can be tracked in real-time. As a result, insights are more up-to-date and detailed. Complex financial data and ratios are analysed and instantly translated and summarised into understandable reports and recommendations. Credit Managers can thus make faster decisions. Predictive analytics enables them to predict future credit risks by recognising patterns that are not visible with traditional analytical methods.
Besides traditional financial ratios, AI systems can also analyse data from social media, news sources and other digital platforms to get an overall picture of a customer's creditworthiness. This can be especially useful for assessing start-ups and small businesses that may not have extensive financial histories. Although this kind of alternative 'dataset', especially if it involves private data, will have to be explicitly considered in terms of laws and regulations. Think AVG, the General Data Protection Regulation (GDPR) in Europe and the Consumer Financial Protection Act (CFPA) in the US.

Simply relying on numbers and sophisticated algorithms is not enough. Time and again, it is important to understand and stay on top of the specific context of companies. Financial analysis of a company's figures as well as looking at the macroeconomic situation in which a company is evolving is the basis of the overall assessment. After that, it is important to go into depth and look for the why behind the facts. Why are there losses? Why are there payment difficulties? Why are we seeing rising bank debts? And the answer to "why" the Credit Manager finds out by maintaining close contact with the debtor. More important than the analysis is the information Credit Manager gets directly from the company.

An important part of assessing a company is determining how strong the shareholders are as well as the management. Shareholders determine how much capital they inject into a company. It indirectly reflects how much confidence they have in the company. They also determine what strategy the company follows. The management has to 'prove' that their business model produces effective returns. This is best found out by talking to them. It is also useful to examine linked companies as well as the holding company.

Forward-looking elements are always probed in discussions with customers and also suppliers. The obvious thing to do is to discuss the development of order intake and compare it with the previous period. Procurement costs are also important. They have a major effect on profitability. The impact of geopolitical turmoil can be large. Have companies hedged against this? Sudden increases in commodity prices can be fatal for companies. It is important to know what risk mitigation measures are in place.
Recognising early warning signals helps Credit Managers to act proactively and avoid potential losses. Repeated requests for payment arrangements may be a signal that the customer is struggling financially. This can also be detected early by monitoring payment behaviour. Deteriorating credit scores, negative financial statements and incorrect or incomplete financial information can all be red flags. So are changes in communication style, such as less communication or not responding to information requests. Unrealistic promises about future payments and perhaps aggressive behaviour are also unmissable signals.

The rise of new technology gives the appearance that the Credit Manager's work is almost completely automated. This is indeed appearance. The human factor is invaluable and is also indispensable. The combination of technology and human skills ensures optimal credit management. Data analysis offers undeniable insights, but it is only on the basis of the judgement of the experienced Credit Manager that the company can make decisions. The human ability to understand context and nuances is decisive in complex credit assessments.

Not for nothing is an important attribute for Credit Managers the ability to listen well. No matter what the customer says, "why" is always heard in the back of the mind. The Credit Manager must be able to connect with any customer type and build a sense of mutual trust. Then you will get companies to be willing to share not only bad news with you but also the measures they take to stay ahead of this bad news.