2. Review a Businesses’ Credit Score by Running a Credit Report
Another useful way to determine the creditworthiness of a customer is with a business credit report to get their credit rating. This report illustrates a business’s ability to pay invoices based on its payment history and public records. The credit report provides a profile about the business, financial data like annual sales, invoice activity and credit limits over several years, legal judgements and collections activities, and a business credit score.
The business credit score is a measure of a company’s financial stability and can predict how likely they are to pay you on time. Typically, the score is between 1 and 100, with a score of 75 or higher considered excellent. You can purchase a business credit report from business credit reporting agencies including Dun & Bradstreet, Equifax Business and Experian Business.
It is important to remember that credit reports are based on information made available by the provider according to a snapshot in time, which is not necessarily apparent to the user. Users of credit reports should understand that the information available may be upwards of a year old and may not reflect real-time developments in the company's creditworthiness. It may be necessary to combine credit reports with additional credit assessment tactics, such as risk data analysis that comes with a trade credit insurance policy.
3. Ask for References
In the process of assessing creditworthiness, companies will often request trade references before extending credit to a customer. Trade references can include the customer’s bank, as well as businesses or suppliers that already extend trade credit to that customer.
Good questions to ask these references include:
- How long the business or supplier has extended credit to the customer;
- The credit or purchasing limit the business or supplier has extended the customer;
- When the customer’s last purchase was and the amount;
- How many times the account has been late
It is important to be aware of potential selection bias when reviewing bank and trade references. When asking a prospect for their references from other suppliers, for example, they are most likely to provide information on companies they pay on time and omit companies that they don't.
Collection of this information can also consume a great deal of time as you are dependent on receiving timely replies.
4. Check the Businesses' Financial Standings
Companies that want to do business with you should not hesitate to provide the financial information that will help you determine their ability to pay for your goods or services. To find out how a company is doing financially, you should ask for and review its certified financial statement in order to learn about the company’s financial performance.
You should also ask for and review the company’s cash flow statement, which indicates the company’s current operating results.
5. Calculate the Company's Debt-to-Income Ratio
Another way to determine a client’s creditworthiness is to calculate its debt-to-income ratio. This calculation shows you what portion the company’s debts make up its earnings. To determine the ratio, divide the company’s monthly debt payments by gross monthly income. These numbers are available from the company’s financial statement.
The lower the number (below 36) the better. However, good debt ratios vary from industry to industry. It is important to understand what those baseline ratios are.
6. Investigate Regional Trade Risk
When assessing creditworthiness of a client, it is important to review the risks inherent in the geographical region where your client is located. Country-specific credit risks are affected by fluctuations in currency exchange rates, economic or political instability, the potential for trade sanctions or embargo, or other issues.
These are all factors that can negatively impact a potential client’s cash flow and make trade credit a risk. Allianz Trade can help. We offer a library of research about sector and country risks that can help inform your decisions about extending credit. In addition, we can leverage our credit-risk grading model to help you forecast credit risks and potential customer defaults.