Maximizing Opportunity Through Credit Risk Management
“The Chinese use two brush strokes to write the word ‘crisis.’ One brush stroke stands for danger; the other for opportunity. In a crisis, be aware of the danger–but recognize the opportunity.”- John F. Kennedy, Speech in Indianapolis, April 12, 1959
It’s important to reconcile credit risk management strategies with the broader objectives of your company. The pressing issue is always minimizing your company’s exposure to risk, but meeting sales goals is equally important when it comes to growing the business and gaining managerial support.
Ultimately, the goal of credit risk management is to optimize profitability by balancing opportunity and risk in the most favorable way possible. This means maximizing sales volume while minimizing the risk involved. Open account terms can encourage buying, but every sale that’s not conducted on an upfront cash basis carries some risk that the seller will not be able to collect the money owed.
4 Effective Credit Risk Management Strategies
Creating and implementing effective policies to improve profitability while controlling for risk and losses is a demanding task, but one that can be achieved with a sophisticated approach that takes advantage of all available credit risk management strategies. There are a number of basic approaches to managing credit risk.
1. Avoiding Risk — Refusing to issue credit to high-risk accounts is part of most credit risk management strategies. However, many of your potential customers may fall into the “high-risk” category. Drawing an appropriate threshold that balances risks and rewards is key in this regard. If it’s too high, sales may suffer; if it’s too low, unacceptable losses can occur. An empirically tested threshold that’s in line with overall company goals is important to getting high-level buy-in and optimizing profitability.
2. Controlling Risk — Creating a plan to reduce credit risk in existing accounts can help regulate the level of risk your business is exposed to.
3. Transferring Risk — Risk can be transferred through trade credit insurance, financial guarantees, and other means to offload or minimize risk exposure. As banks, insurance companies, and other major creditors tend to view their risk on a portfolio-wide basis, this has become a popular option that can be achieved through a variety of mechanisms.
4. Accepting Risk — Finally, accepting high-risk accounts can be instrumental for businesses that have excess inventory, adequate reserves, high profit margins, or that are looking to aggressively expand market share.