Credit Guide 03/22: Risks and metrics in analysis of high-growth companies
10. March 2022.Credit Snapshot 03/22: Metro Cash and Carry – Loss generation continues, strategic direction unclear
22. March 2022.Knowing and understanding your customers’ creditworthiness is absolutely essential, not only to assess the likelihood that your customer will default, but also for many other, initially hidden reasons.
What is creditworthiness?
Creditworthiness (ger. Kreditwürdigkeit or Bonität) is the ability of a company to meet its financial obligations on time and in full. In other words, it is the synonym for a company’s debt service capacity, because even a sale on credit represents a way of lending. However, the term “lending” should be understood here in a broader sense because it is not solely about lending money. It’s about “lending” trust that the company will do something for you. More specifically, you expect your customer to pay in full and on time, but you also expect the customer to come back ordering more in the future and that your business with him will not have adverse reputational impact on you.
What does a detailed analysis of customer’s creditworthiness include?
The purpose of a detailed customer creditworthiness analysis is to provide you with relevant information for reaching strategic business decisions. However, it is important to remember that not every manager in each industry is focused on the same elements. Still, the analysis of the customer’s creditworthiness must contain at least the following:
- Overview of the key weaknesses and strengths of the analysed company.
- Insight intothe industry risks and the macroeconomic environment in which the company operates.
- Analysis of the company’s competitive position through the assessment of its market position, concentration risks, and operating efficiency.
- Assessment of the company’s financial risks, including the analysis of cash flow generation capacity in relation to the level of leverage, liquidity, capital structure, and financial policy.
- Overview of the company’s adjusted financial statements for the last 5 years.
- Financial forecasts for the following 1-3 years including different scenarios.
- Credit rating of the company, including the rating scorecard.
- Statistical assessment of the probability of default.
In addition, you may be interested in the recovery rate in the event of the company’s default, which requires a specific assessment.
What are the benefits of a detailed analysis of customer creditworthiness?
With detailed analyses of your customers’ creditworthiness, you will:
- Minimize the risk of non-payment by spotting Early Warning Signs (EWS) of deteriorating creditworthiness of your customers.
- Distinguish between riskier and less risky customers, which allows you to take different approaches to structuring business relationships with them.
- Better manage working capital due to improved assessment of the stability of customers’ demand, which leads to better sales and production planning.
- Find out your customers’ usual payment terms and understand how you rank in relation to other suppliers.
- Understand the key drivers of your customers’ business, as they impact demand for your products and services. In this way you can identify opportunities to expand together with the customer and understand whether the customer is a reliable partner.
- Anticipate your customers’ strategic moves and adjust your strategy accordingly.
- Identify a potential takeover target for a vertical integration.
- Calculate your customers’ actual profitability considering the implied risk of default.
- Apply the best credit management practices, because we must not forget that banks in Croatia are mostly secured creditors, which increases their recovery rate compared to suppliers who are normally unsecured creditors.
How many customers should be analysed in detail?
There is no specific rule, and it depends on each company and the industry it operates in. It may be enough to analyse your 5 or 10 largest customers, or you may also use Pareto’s 80/20 principle as a guidance. The most important thing is that you are comfortable reaching important strategic decisions by applying your approach, but also taking into account the cost-benefit ratio. A useful guidance can also be to put in a relationship the amount you are ready to lose by doing business with a particular customer and the cost of a detailed analysis.
How much does a detailed analysis of a customer’s creditworthiness cost?
The cost of a detailed analysis of customer creditworthiness depends on several factors, such as the type of analysis (Risk Indication, Risk Opinion, Credit Analysis or Full Credit Analysis), the complexity of the analysed company, your specific requirements to be included, deadlines, etc. Nevertheless, the price should not exceed a single digit amount of HRK thousand (from few hundred to a bit over 1,000 euros).
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