Credit risk is a term applied to the dangers associated with lending anyone goods, services or money.
It can be associated with the risk of a borrower failing to repay a loan, or a business failing to pay for goods or services it has received. Low risk customers are deemed most likely to pay based on an assessment of liquidity and payment history.
How to minimise credit risk
Minimising risk is an important part of any organisation’s approach to credit. At Atradius we recommend a combination of due diligence and credit insurance. To help support our customers’ own research, we provide a range of free publications including the quarterly Country Risk Map, which gives an overview of the level of trading risk associated with individual geographies.
Our suite of Credit-to-Cash Briefings are designed to support businesses with insight into many issues affecting trade and export, including tips on subjects such as how to complete a risk assessment of your account receivables and how to make efficient collection calls.
If your business reports according to the International Financial Reporting Standards (IFRS), your credit risk provisioning processes must comply with the expected credit loss impairment principles that were introduced in January 2018. Learn more about IFRS9 Impairment Standard.
Credit Insurance is one of the most robust ways you can minimise credit risk, but it is not the only approach. Here are some examples.
Trade with a credit insurance policy. If your customer fails to pay, trade credit insurance safeguards your business with the guarantee that your insurer will pay you if your customer doesn’t. Learn more about Atradius Credit Insurance.
Insist on payment upfront. Demanding payment in advance or cash on delivery is one way to minimise credit risk. This approach can be much less attractive to potential customers, however, so you’ll need to liaise with your sales teams to find the right balance for your business.
Secure a Letter of Credit. Issued by your customer’s bank, this is a guarantee that they will meet the terms of the contract or invoice. The downside is that these can be expensive, usually require evidence before they’re honoured and you will need a new Letter of Credit for each invoice (which can cost a lot of time and money if you need security for many invoices). Learn more about Letters of Credit.
Outsource your invoices to a factor. Factoring companies buy your invoices from you and put in the work to chase any unpaid fees. They protect you from the risk of non-payment, but they also take a share of your profit by paying you less than the face-value of the invoice.
Gamble on self-insurance. As with all of the other credit risk reduction options, you should ideally start trading relationships by assessing your customers. Does their previous trading history or the geopolitical location of their business suggest potential payment issues? If yes, it may be safer to trade with a customer that presents fewer risks. However, even if the risks appear low this may still be a gamble as some businesses can go bankrupt with no warning.