What is Customer Creditworthiness and How Can It Be Determined?
Simply put, creditworthiness is the ability of your customers to pay you, which is why it’s important to understand how to determine creditworthiness before you extend trade credit. To determine the creditworthiness of a customer, you need to understand their reputation for paying on time and their capacity to continue to do so.
Those factors include their revenue and outstanding obligations. You also need to understand the company’s future business prospects and trends within their industry that could affect their ability to pay you.
Using the 5 Cs of Credit to Evaluate the Creditworthiness of a Company
You can determine the risk of extending credit and quantify credit limits by using the five factors termed “the five Cs of creditworthiness.” While there are no strict guidelines for how to weigh these 5 characteristics, considering each can help you perform a credit assessment to determine the likelihood of default and potential financial loss should you extend credit.
The five Cs that help you determine the creditworthiness of a company are:
- Character: It is important to determine that your trade partner has the background and credentials that indicate they are trustworthy and have a reputation for sound business practice. To assess character, you should call business references, review the business’s credit history, and analyze the reputation the business has in the industry.
- Capacity: You want to make sure the prospect or client can pay your invoices. Understanding the business’s cash flow situation will provide this insight. You should examine cash flow statements, analyze its debt-to-income ratio, and compare that to historic revenue.
- Collateral: If your invoices remain unpaid, your client could liquidate certain assets to settle the debt. Part of an effective credit analysis is to understand what assets your client or trade partner has, such as equipment or accounts receivable.
- Capital: Understanding how well capitalized your treading partner is can help you understand their ability to pay for your goods or services. Ask to review a potential client’s certified financial statement.
- Conditions: Take a close look at the conditions that could affect your trade partners’ business. The economy, political situation in the county of operation, and threats or opportunities for the industry the business operates in can help you understand if the business will continue to be viable or if challenges could indicate a potential for late payment.
How to Determine the Creditworthiness of a New Customer
To protect your business from late or nonpayment on invoices, it is important to use the right tools to thoroughly check the creditworthiness of customers before you extend credit. Here are six ways to determine the creditworthiness of potential customers.
1. Assess a Company's Financial Health with Big Data
Big data is helping companies improve the efficiency of their credit departments, now empowered by tools that substantially reduce the time required for critical tasks. Trade credit insurance is a prime example of how companies can easily obtain more customer data to improve credit processes.
Using Allianz Trade as an example, the credit insights we provide to customers come from a variety of sources, some of which include:
- 85 million+ companies monitored in our proprietary risk database
- 1,700 sector-specific credit analysts in 62 countries + 30 full-time data scientists
- An extensive array of proprietary and third-party data sources
- Direct contact with monitored buyers to request and analyze financial statements
- Real-time past-due and claims reporting from 55,000+ customers around the world
- Machine learning and artificial intelligence to augment our expert analysts
The more extensive the insurer’s database, the better their access to invaluable customer information, based on data from a worldwide network of analysts and clients. These analysts have local expertise and customers that give information about their payment experience with their clients. This confidential financial information about companies gives much deeper insight into their strengths or weaknesses. It helps spot high-risk companies before it’s too late.