How to further assess credit risks

Credit risk is an inherent element present in every credit transaction. It arises from the management’s operations, financial condition and other related circumstances of the company and/or debtor. Be it a single proprietorship or a corporation, the basic question that we would like to know is how can this entity handle and repay the credit exposure and what are the circumstances that will prevent the payment of its debt or obligation when due. The risky transaction is the one which creditors want to avoid, for they would spare themselves the losses and complication often resulting there from. Since credit involves risk, it is not the one which has any element of risk, but the one which has an abnormal and dangerous amount of risk that should be avoided.

This is the very reason why we have to be diligent in handling and evaluating credit risk. The principal factors to be taken into account in deciding whether or not credit should be extended, in what amounts, and on what terms, are simply called credit risk analysis.

Sound business management requires assessment of credit risks relating to credit sales transaction and in any investments for that matter in exchange for future financial gain. Investors and business owners are in general, risk takers. So if a firm’s management takes an action that increases its risk level, that firm should require a higher expected financial gain or return on more risky investments than it would on less risky investments. In this context, I personally believed that granting credit should be considered a risky business and must be fortified to ensure a more profitable return.

There are several approaches to risk analysis. In as much as this column is more concerned with determining credit risks and due to space limitation, I am going to discuss some “intangible” parameters of credit risks analysis. 

First, management’s business plan and adaptability to change. Change is unavoidable – companies either grow or die. No matter how unwelcome some changes will be, they come and are indeed inevitable. One must ask for the company’s plan for the ever changing landscape as the company grows. One must find out if there are short, medium and long term plan laid out by the management of the company, be it for operations, finance, marketing, etc. The simple question to be asked is that: How can the company continuously grow and any plan to expand? What other business activity is the company trying to break in and is it sustainable? What business does it want to be in the next 2-5 years? Are all available resources, including human resources, being optimized to implement this plan?

Second, continuity of management. Some businesses succeed only because of the ability of its management to continuously guide and nurture its day-to-day activities. Unfortunately, a lot of similar companies would fail in the hands of anyone else. When approving the credit application of such enterprises, particularly those requiring more than 3 months to complete payment, it is especially important to know that present management is satisfactory and will remain so during the life of the credit transaction.

For credit & collection questions and inquiries, call or text 0917-7220521 or email at elimtingco@cibi.net.ph