Risky Business Part 1: Credit Risk

Risky business, its not just an 80's movie with a great title, its the nature of business itself. This week in major financial news sources the BP oil crisis continues and allegations of BP using "risky" or sub-par equipment highlighted. Other articles highlight the unnerving decline of the EU economy and its effect on Asian export businesses. Risk is undeniably the ever-present shadow of success in the markets and in business. Everyday businesses assume various risks in exchange for potential returns or rewards to capitalize upon. How does a manager, an executive of the company, or of a division within a company manage risks?
This article is the first of a three part article which will outline specific areas of risks related to external factors such as client risk/credit risks, export and political risks. Business owners must be proactive in risk prevention as they are in risk management. There are a few key areas where companies can focus their risk prevention efforts.
Companies small and large invest time, money, and hard work to secure new clients and retain previously existing clients. The flip side of the sales coin is the offer of credit terms and the associated risk. Most business in the US and globally is done on credit terms or financing and the more favorable terms are to clients, the easier a sales is to close. But, businesses must conduct due diligence and implement credit qualification standards for every potential client irrespective of how established as a brand name the client is or despite their reputation in the marketplace. Companies aggressively looking to develop business and execute purchase orders with new clients may overlook risk and ignore previously established credit standards for the sake of closing deals or securing new clients. In other cases, proper credit terms and standards may be neglected by small businesses because they may not have the budget nor the staff available to support a robust credit department in their company. Every sales opportunity must be subject to sound credit analysis, so that a company can best assess the ability of the potential client to repay for the goods or services they are purchasing.
Sales is about negotiation and maximizing the bottom line. Credit analysis and due diligence is about zero negotiation and 100% risk prevention. Here is an example: A prospective new client places the largest order to date to ACME Foods, signing a purchase order and/or a sales contract with Acme Foods. Then ACME Foods produces the product and ships, then invoices the client. ACME has now invested large dollars, time, and resources in execution of that sale. What happens if the client pays a 30% deposit upfront, but as for the balance... 2months down the road and even 3months down the road, there is no payment from the new client? ACME Foods has experienced a significant loss, and now must find a way to reconcile cash flow issues and implement a workable collections strategy, they are now in the mode of Risk Management. If they had Risk Prevention processes in place, through credit analysis would have been completed and the sale would have been subject to the risk assessment. Even in cases where there is a high level of risk attached to a potential client, there are ways to still do business with them if credit risk guarantee or credit risk insurance is utilized.
Centuries old, Credit Risk/Trade Credit Insurance is an under-utilized risk protection mechanism which allows companies to sell to any client whether they are high risk or low risk by protecting the seller from non-payment, default, and other issues of the buyer.
The next article will focus on Trade Credit Insurance and other Risk Guarantees which companies can utilize.
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Nitin Dacha is the Director of Financial Services at Greater Jamaica Development Corporation. Nitin also provides advisory services related to trade finance and project finance through his own advisory firm, Nitin Dacha LLC and can be reached at ndacha@gmail.com or (850) 445-9437.