Managing Marginal Credit Risks

By managing credit risk, credit professionals can ideally avoid losses or at least reduce the amount of bad debt losses the company experiences.  Credit professionals must guard against offering open account terms to marginal credit risks. All of the factors listed below are indications of a marginal credit risk:

• The applicant company was established less than five years ago;
• The applicant company was established less than two year ago;
• It is not readily apparent when the company was started;
• The company cannot provide a list of trade references;
• The credit report on the company contains limited information;
• The new customer cannot or will not provide financial statements;
• Their bank reference refuses to provide information;
• The bank and trade references provide unfavorable information.  Hint:  Remember that the customer/applicant selects the references they provide, so why would they provide any references that would/could/might provide unfavorable information;
• There was a change in ownership or in senior management within the last year;
• The company was recently incorporated;
• The credit application is returned unsigned;
• The personal guarantee is returned unsigned;
• The credit application returned contains incomplete information;
• The applicant provides financial statements but they show areas of concern relating to profitability, liquidity or financial leverage;
• All the trade references given by the applicant are located in a small geographic area;
• The trade references report the account has been opened for two years or less;
• The bank reference reports two or more NSF checks in the last year;
• Calls to the customer are answered by voice mail;
• The debtor company has previously filed for bankruptcy protection;
• The applicant or customer is being sued by other creditors;
• The credit report lists one or more tax liens;
• The credit report indicates that the customer or applicant has been sued in the past by creditors;
• The payment history section of the credit report shows that one or more creditors have placed the account for collection;
• The credit report shows consistent payment slowness;
• The credit report does not show consistent payment slowness, but does show that some creditors are paid on time while others must wait 30, 60 or 90 days or more for payment.

If a decision is made to re-open a marginal account, the credit department needs to exercise appropriate care.  A letter should be sent to the marginal risk account.  The specific payment terms are listed for the "new" customer's review as well as a statement that the previous problems, if repeated, will result in credit being withdrawn again.  The salesperson should be copied on the letter.  The account should be flagged as high risk so that it can be monitored closely.

If an applicant or a customer has a history of slow payment with other trade creditors on open account terms, chances are they will treat your company no better sooner or later.  With that said, establishing payment terms is in most cases a balancing act between the needs of the buyer and the seller.  A good risk management program can reduce losses and identify the potential for additional profitable sales.

© 2010 by Michael C. Dennis.  All Rights Reserved.  Michael is the author of "Credit and Collection Forms and Procedures Manual."  His email address is mcdennis13@yahoo.com