Assessing Credit Risk Before Extending Credit

Extending credit can be a formidable process, especially when extending credit to a new customer or business. “Getting Burned” is something that most seasoned credit managers have dealt with. Credit managers have to balance the risk of extending credit to a new customer with the potential for new sales.

“To increase sales, you need to take some risks,” says Kim Lindgren, CCE at BARR Credit Services. Lindgren should know – she was the credit manager for a large national wholesaler before joining BARR Credit services. Extending credit to new customers or businesses takes some level of risk and trust, but it is an essential component of business growth.

The Essentials of Assessing Credit Risk

A credit application is the first step in extending house credit to a new customer. For an established business, the process is straight forward, and credit managers have many resources available. The following tools are standard practices used to assess risk when extending credit to a new customer with an established business:

A business entity search, with the Secretary of State
Pulling a credit report
Using your National Association of Credit Management (NACM) group membership

Business entity searches are done through the Secretary of State’s website; this search ensures the business is a legal entity. If the credit manager has an NACM group membership, they can utilize NACM’s Lien and Bond department as a resource.

Credit reports can be pulled from the ‘standard’ credit bureaus, like Dun & Bradstreet, Experian, and TransUnion. Credit terms can differ based on the industry. Some credit reports can be industry-specific. When industry-specific credit reports are available, it is easier to establish appropriate credit terms for the specific industry.

It is a little more complicated when establishing credit for a newly formed business because of the lack of available information. Newly formed companies with less than three years of financial history are considered a greater risk than established businesses.

However, Lindgren says, “A successful credit manager finds a way to establish a baseline credit limit based on the owners’ personal credit history. I’ll figure out a way to establish a sale. I pull personal credit reports and have personal guarantees from all principal owners. If approved, the new businesses will often be extended credit solely based on their report. Otherwise, I will approve them on a cash basis until they have established some trade history.

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Changes in the Application Process

As Lindgren points out, much of the credit application process is automated with today’s technology. Most of the previously collected information is now gathered when a customer or business applies on an online credit application portal. With the necessary software, the information provided automatically produces a credit score.

The credit manager utilizes the credit score to determine how much credit should be extended. But this doesn’t necessarily mean rejected applications make the customer or business ineligible. “Everybody’s in business to sell something,” says Lindgren. Further elaborating, she explains, “that most companies have different levels of authority, so rejected applications often go to a ‘second set of eyes to be re-evaluated before a final determination is made.

Risks and Deal Breakers

Lindgren says, “Taking risks is necessary for business, and every situation is different. There won’t be any information about a brand-new business because they’re just starting up. So, you’re going to extend them credit based on their personal information and put a credit limit there so that they don’t get out of hand.”

Lindgren further explains, “For this type of account, credit managers can utilize systems that can be set up to put a “soft stop” on the account if they go over their limit. A “soft stop” allows the credit manager to decide if they want to approve a certain percentage over the original credit limit.”

Deal breakers come into the picture when the business goes over the newly approved credit limit and starts to slow-pay their invoices. This indicates that their credit limit is too high and should be reduced to something more manageable.

Keep in Touch

Communication is the essential aspect of being a credit manager. Most businesses want to pay their bills. However, when they run into cash flow problems, being understanding and respectful will get you paid faster than using heavy-handed demands. Lindgren says, “My goal is to have a relationship with the customer so that when there’s only so much money to go around, and it’s not enough for everybody, I want to be at the top of the list.”