importance of working capital management

Understanding Credit Risk

Now more than ever, it is so important that you increase your working capital in order to protect your business. A recession and global pandemic means that every business is shaken up. It is definitely possible that some of your customers will be unable to pay your business if you sell on credit terms. This is where understanding credit risk can help save your business. Working capital management has a lot of components, but the most important part is credit risk management. Business credit or trade credit is an important factor in running a small business. Selling to other businesses on credit terms affects cash flow and requires credit risk management to protect your business.

What is credit risk management?

Managing credit risk requires monitoring your customers’ business credit as a larger picture of their financial health. You want to be sure that you will be paid for the goods or services provided. Credit risk management is the process of lowering the risk of customer non-payment by providing reasonable credit limits and terms. There are a lot of components involved in managing credit risks, but it’s crucial to have a process in place. Some businesses use third party tools to show the status of their accounts receivable. These tools can display an aging report, the amount you have outstanding, and average payment time.

What is a credit limit?

A credit limit is a cap on the amount of credit you extend to a company. Use business credit monitoring companies like Dun & Bradstreet or Experian to analyze the credit history of your clients. Additionally, you can ask for trade or credit references. Generally, it’s best to set the credit limit low and increase gradually over time with early or on-time payments. When setting a credit limit, you want to make sure that your business will be protected from customer non-payment, but also you want to be able to continue doing business. Having too low of a credit limit means saying no to new opportunities. Having too high of a credit limit means you might get burned if that customer goes out of business.

How to assess credit limits:

Checking business credit through business credit bureaus and requesting trade references are two ways to assess credit limits. Doing a quick internet search on the company is a good idea. This search may show you good signs like business growth or awards, but this search could also show you warning signs like changes in management or branch closures.

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What are credit risks?

Credit risks boil down to clients that could hurt your business by not being able to pay. A credit risk could be a small account with poor credit and the potential to go out of business, or a credit risk could be a large account with high concentration that could end your business if they go insolvent.

paying on credit terms

What is a credit concentration?

A concentration refers to a high amount of credit extended to one account. The risk is that if that business fails to pay, your business would suffer. Managing the amount and repayment terms of credit extended to a large customer can help mitigate the risk associated with credit concentration.

Paying on credit terms

Extending credit terms cautiously is the best measure to take for mitigating credit risks. It is best to avoid concentrating credit with one or two accounts. Having diversified sources of payment with strong credit history is the best course of action for ensuring early or on-time payment.

Credit risk and online lenders

Online lenders like Fundbox or Kabbage determine your business’ credit risk in minutes through algorithms. Your funding potential is based on this assessment. Invoice factoring companies like Eagle Business Credit employ finance professionals to assess credit risk of our clients. Our flexibility in funding potential is because we understand the human side of business that an algorithm may miss.

Managing credit risk

Best practices for managing credit risk require time, experience, and effort. It can be difficult for a small business to divert resources to credit risk management. This is where utilizing a third-party receivables management company is beneficial. Eagle Business Credit offers credit monitoring and professional advice to mitigate credit risk for free with a factoring facility. Invoice factoring services provide immediate payment on your open invoices as well as receivables and credit risk management.

understanding small business credit risk

How Can Invoice Factoring Help Protect Your Business?

Invoice factoring is not only a tool to help manage your receivables, but it’s primarily a tool to finance your business. Invoice factoring is designed to improve your cash flow and minimize the risk of customer non-payment. Essentially, you sell your invoices to a factoring company like Eagle Business Credit at a discount. This discount will typically be between 1% and 4% of the invoice amount. Eagle Business Credit then pays you the same day your invoice is issued. You no longer have to wait for your customer to pay after your agreed upon credit terms. Non-recourse factoring is a step further into business protection. With a non-recourse facility, the factoring company takes all the risk of customer non-payment. You have immediate payment for your invoices and the capacity to keep selling without worrying about customer non-payment.

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