A 360° approach to risk grading: why numbers are not enough?

In trade credit insurance, you ultimately want to predict the likelihood that a company will pay a supplier. Credit Analysts place a credit grade so that underwriters can decide more easily if they allow trade credit insurance coverage on a particular company or not. Many people still think that risk grading is based on just a handful of financial documents but this is not always sufficient to determine the financial health of a company.

Credit analysts cannot just rely on figures and advanced algorithms to help assess credit risk. This is very important to understand the specific context of each company and there are a number of factors to consider in order to determine a company’s financial health and its future risk exposure.

We asked Pieter Coussens, Senior Credit Analyst at Euler Hermes BeLux to explain us the key things to look out for when determining the creditworthiness of your customer.

The financial analysis of a company's figures, together with an inspection of the macro-economic situation in which a business is evolving, can be the basis of the overall assessment. After that, it is important to dig deeper and look for the "why" behind the facts. Why are there losses? Why are there payment difficulties? Why are we seeing rising bank debt? And the answer to "why" is best discovered through close contact with the debtor. More important than the analysis, therefore, is the information that you receive directly from the business in question. Our establishment of in-depth relationships with businesses all over the world is what makes our Euler Hermes Grades so reliable.
In assessing a business, an important point to examine is the shareholders and management and how strong they are. Shareholders determine how much capital they inject and leave in a company, indirectly reflecting how much confidence they have in their business. Management must likewise be able to demonstrate to us that their business model delivers an effective return. This can be discovered through effective conversation with them. In addition, we always investigate the linked companies as well as the holding company, because cash can always be transferred to other entities.
Every business has suppliers and customers, and you have to act as a reliable partner so you can look for solutions together at every hurdle. Ideally, your customers and suppliers will be sufficiently diversified, both geographically and sector-wise. This will enable you as a business to be more resistant to macroeconomic shocks in one specific country (e.g. Brexit) or sector (current scarcity of certain inputs). The strength of your business depends partly on the strength of your customers. If your customers are experiencing difficulties, a domino effect is never far away. This is why we always ask CFOs whether they work with trade credit insurance themselves.

All Euler Hermes analysts around the world work in the same way. They must arrive at the final grade by keying in four factors, with each factor having a certain percentage weight.

These four factors are the following:

  • Shareholders/management/strategy
  • Profitability
  • Balance sheet strength/liquidity
  • Cash flow

For each factor, you have to explain why you have assigned that particular value. This means that anyone using the grade can see at a glance why the final grade is good or bad.

In each meeting, the forward-looking factors of the company are explored. We consistently ask about the evolution of the order intake compared to the previous year, as well as the size of the order book. Where necessary, we try to obtain this actual list of orders. These days we are faced with skyrocketing input prices, so it is crucial to know how to make sure the orders are still profitable. Are price revision clauses included in the offers? For many businesses, the current price increases and general scarcity of many inputs are worse than the covid-19 crisis.
In my opinion, the most important quality of a good analyst is being able to listen well and process the information quickly. This enables you to challenge each response from the CFO with new questions. Like a small child, you must face each comment from the CFO with the word "why" in the back of your mind and keep questioning everything. In addition, you must also be able to form a good relationship with any type of CFO. You have to be able to project a certain sense of trustworthiness so they are also willing to share bad news with you.

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