Making the grade: what you need to know about risk grading and credit assessment

Have you ever wondered what happens in the period between submitting a credit limit request and receiving an answer?

To the uninitiated, the process may seem daunting. However, credit assessment is foundational to the day-to-day of an insurance professional. Our training and the wealth of experience of my fellow credit analysts and risk underwriters mean we can make the correct decisions fast. Combined with our grading system, we ensure the process is streamlined, equitable, and accurate. 

First things first: what is a “credit limit request”? In simple terms, if a client approaches their insurance underwriter with a request to cover their sales to their own clients, known as buyers, from non-payment, they are making a credit limit request.

At Allianz Trade, our first task is to assess the risks and grade the buyer from one to 10. It’s a sliding scale: one is exceptional, five is average, while seven is weak – and a score of nine or 10 means the company is at risk of failure. We make this decision based on the company’s financial data, which is either publicly available (filed at Companies House in the UK, and other registries elsewhere) or shared with us regularly. When examining the data, we look at specific areas to guide our assessment. 

1.    Ownership, management, and strategy

This refers to the way the company is governed and led. We ask questions including:

-       Is it publicly traded or privately owned?

-       Who is calling the shots, and what is their experience?

-       What strategy have the company’s leaders enacted?

We also look at the track record of the company’s leadership, and their ambitions. We want to see that the leaders are looking to the future while remaining cognizant of their company’s current position.  

2.    Revenue and profitability

We’re especially interested in changes to the company’s revenue over time. We want to understand if the revenue is declining, stable, or – ideally – growing. We also look at the company’s gross profit, as well as operating and fixed costs to get a full picture. We typically find this information explicitly in the profit and loss account — which is only published by certain companies — but we can also find it indirectly via the balance sheet.

3.    Liquidity and financial leverage

To gauge liquidity we look at working capital, which helps us understand how quickly the company can turn assets into cash. A company’s liquidity impacts its financial leverage because it affects the company’s ability to take on debt. We also want to look at how much debt the company has, how it is composed, and if its loans are secured or not. Essentially: are they using their money effectively? This information is found largely on the company’s balance sheet.

4.    Cash flow and coverage

Cash flow concerns the money coming into the company from its operating, financing and investing activities, which indicates a company’s capacity for financial recovery.  It is driven by earnings before interest, taxes, depreciation and amortization (EBITDA) and the movement of working capital. We look at whether the company has capital expenditure, its cash is decreasing, or its assets are reducing in value. We want to see that it has coverage, which is the ability to pay its interest payments on any debts.

5.    Sector and landscape

Together with these four main areas, we also take other factors into account. Key amongst these is the sector the company operates in, as different sectors carry different levels of risk, and the prevailing economic, political, and legal landscape for the company and its industry.