Credit Risk Management

Risk and opportunity go hand in hand, and in every business there must always be a balance between the drive to achieve a specific volume of sales and the credit risk associated with selling on open account terms, or alternatively accepting a customer's check in payment. With every sale, there is some question about the seller's ability to collect the money owed. 

Credit risk management should be developed within the context of the goals and objectives of the company as a whole. While your main focus should be on managing and controlling the company's exposure to credit risk, you cannot manage your risk without regard for the company's need to achieve certain sales targets. Successful credit managers who blend credit risk management into their employers' overall business philosophy will gain the support and trust of senior management by creating policies and procedures that optimize sales, profits, and cash inflows while keeping risk, delinquencies and losses at acceptable levels.

Credit risk can be defined as the risk of financial loss resulting from the failure of the debtor to honor part or all of its obligations to pay creditors' invoices as they come due. The goal of credit management is to optimize the company's sales and profits by keeping both credit risk and payment delinquencies within acceptable limits. Sound credit management involves finding the right balance in the risk/reward relationship between sales and bad-debt losses.

There are a number of ways to manage credit risk. The most common include:

• Accepting risk,
• Controlling risk,
• Avoiding risk,
• Transferring credit risk.

Avoiding risk can be accomplished by refusing to extend credit to high-risk accounts. However, in most companies this is not a viable option since so many customers could be classified as high risk that refusing to sell to them would reduce sales to unacceptable levels.

Controlling risk in volves developing a comprehensive plan to reduce credit risk in the company's accounts base, then implementing that plan, and monitoring the credit department's efforts to carry out the plan.

Accepting risk involves a decision to dobusiness with customers identified as high risk. These tend to be companies trying to gain market share, companies with high profit margins, companies with excess inventory, and companies with adequate reserves for the bad debt losses that are almost certain to accompany this policy.

© 2011 by Michael C. Dennis.  All Rights Reserved