SMEs are the backbone of the UK economy. In fact, they account for 99% of all businesses in the country and employ 60% of the workforce!
Despite their importance to the economy, SMEs are currently owed £50 billion in unpaid invoices, putting tens of thousands of businesses at risk of insolvency.
Because of this late payment crisis, it's important that SMEs understand credit risk management and how to protect their business from potential financial setbacks.
In this blog post, we will explain what credit risk management is, why it's important and give four solid actionable pieces of advice on how to manage your business credit risk effectively.
What is credit risk management?
Credit risk management is the process of assessing and managing the risk of default on financial obligations. Put more simply, it's about making sure you don't get into debt trouble and can continue to operate your business as usual, even if some customers or clients stop paying their bills.
Effective credit risk management usually involves:
- Conducting credit checks on new and existing customers/clients
- Managing customer credit limits
- Reviewing your business's debtors regularly
- Having a clear collections policy in place
Why is credit risk management important?
There are a number of reasons why managing your business credit risk is essential. Firstly, if your customers don't pay you, then your business will struggle to meet its own financial obligations. This can quickly lead to cash flow problems and, ultimately, insolvency.
Secondly, if you don't have a good credit risk management strategy in place, you may be missing out on potential sales opportunities as some customers may only be willing to do business with you if they're confident that you can pay them on time.
Thirdly, having a good credit risk management strategy can help you to save money as it may help you to negotiate better terms with your suppliers.
Finally, good credit risk management can help to protect your business's reputation as customers, suppliers and other businesses will have more confidence in working with you if they know that you have a good system in place for managing your credit risk.
Credit risk management is especially important for SMEs because they are less likely to have the resources to recover from a major financial setback. That is why effective credit risk management is key for any SME. It can help protect your business from potential financial disaster.
What are four tips for effective credit risk management?
To put effective credit risk management, you need to have a clear understanding of your business's financial position and what your credit risks are. This means having up-to-date financial statements and knowing your current assets, liabilities and equity. You should also regularly review your customer list to identify any customers who may pose a credit risk.
You also need to have a credit policy in place. This should outline your company's standards for extending credit, including the maximum amount of credit you're willing to extend to anyone customer and the minimum payment terms you require.
Establishing good risk management practices is vital. This includes monitoring your customers' creditworthiness on an ongoing basis, using automated tools if possible, and having well-defined credit terms and limits in place, which bring us to our first of four actionable tips:
Credit check potential customers
Conducting a credit check as part of the onboarding process for new customers is essential. This will give you a good indication of their creditworthiness and whether they're likely to be able to pay on time.
Technology can help you stay on top of your customers' credit risk by automating the process of monitoring their payment history and flagging up any late payments.
With Chaser, not only do you have access to all your customer's payment data in one centralized hub, but you can also regularly credit check your customers to stay up to date on their creditworthiness.
Most people view credit checking as a one-and-done process, but it's important to keep tabs on your customers' credit scores over time as their circumstances can change.
If you're not already doing so, start monitoring your customers' creditworthiness today. It could save your business a lot of money in the long run.
Draft your credit lending terms
Whenever your sales team puts an agreement in place with a customer, it should always include a clear and comprehensive section on terms of credit.
Your terms of credit should include:
- The amount of credit you're extending to the customer
- When payment is due
- What interest rate will be applied to late payments
- Any other relevant information, such as whether or not security is required for the loan
If you don't have clear and concise credit terms in place, you're at a disadvantage if something goes wrong. It's much harder to enforce payment if you haven't laid out the rules from the beginning.
Open communication and making sure everyone is on the same page in advance can help reduce the chances of any misunderstandings.
Before you extend credit terms to a new customer, take the time to do your due diligence. Check their credit score and review their payment history. This will give you a good indication of how likely they are to repay the debt on time.
Finally, make sure you have a clear and concise collections process in place for when customers do fall behind on payments. This will help you recoup any outstanding debts and protect your business from bad debt.
Speak with and trust your colleagues
It takes a village to raise a barn, and it takes an entire company pulling together to conduct effective credit risk management. If you're the only one responsible for making decisions about credit, you're more likely to make mistakes.
Get input from your colleagues, especially those who will be directly impacted by any changes in policy. And if someone on your team expresses reservations about a particular deal, take their concerns seriously.
Like most things in life, credit risk management is something that should be done on a continuous basis. There's no one-time fix to this problem; it requires constant vigilance and communication.
Employees in parts of the company not even connected with offering credit, like marketing, might overhear something about a customer that could be relevant to the credit decision. Make sure you have a communication strategy for ensuring everyone in your company is up-to-date on credit risk.
Develop a standard process for overdue accounts
Standardization is key for any business process, and credit risk management is no different. Having a set process in place for how you handle overdue accounts will help to ensure that everyone in your organization is on the same page and knows what needs to be done.
A credit control policy is a vital part of this and should set out clear procedures for contacting customers who have outstanding payments, as well as what actions will be taken if they don't respond.
If you don't already have one in place, Chaser's credit control policy template is a great place to start.
There are now a number of software solutions available that can help you to automate and streamline your credit risk management process. By making use of these tools, you can free up your time to focus on other important tasks.
With Chaser's accounts receivables software, for example, you can:
- Automatically generate dunning letters, emails, and SMS messages
- View customer balances and payment history
- Get alerted when payments are due or overdue
If you're looking for a more comprehensive solution, our Credit Risk & Debt Management software offers all of the features above and much more.
It's perfect for businesses that want to take a more proactive approach to credit risk management and you can try it out for seven days, commitment-free, with our free trial.
The importance of credit risk management
The answer to the question, 'why is credit risk management important?' is simple. Because it can save your business from going bankrupt.
According to the Federation of Small Businesses (FSB), late payment is the number one reason small businesses in the UK go bust. In fact, SMEs are owed £50 billion in total as a result of late payments, which is around £600 for every business in the country.
Clearly, then, credit risk management is something that all SMEs should be taking seriously. The good news is that, with our actionable tips and Chaser's advanced automation options, credit risk management doesn't have to be difficult.
