Sometimes it can be hard to know if a potential customer is a good or bad credit risk. All businesses need to safeguard their finances from potentially risky customers. You can keep on top of your credit risk management by obtaining credit reports.
Credit reports are an excellent way to help you decide whether you should offer credit services (buy now, pay later) to any customer. To further help protect your business finances, you are also able to see if potential suppliers are partners have any issues that could affect your business.
The importance of reducing credit risk for your business
Trade credit is essentially an agreement between you and your customer that says the customer can purchase services, or goods, from you and they will be able to pay for these at a later date.
These agreements are perfectly normal with transactions between other businesses, and they are highly effective in encouraging sales and stimulating growth for your business.
Of course, there is a catch to all of this. Any time that a business invoices customers after services or products have already been provided, it exposes itself to financial risk; customers may pay late, or even not at all.
Late payments and defaults can hamper the cash flow of your business, so you need to be able to check the reliability of a customer first. Identifying a future customer’s credit rating, or worthiness is a highly effective method of reducing your financial risk.
Review a business credit report
Business credit reports have long been a viable tool in helping risks to your business, and, likely, they always will be. A credit report can outline the ability of a given business to pay their invoices. These reports are based on:
- Payment history
- Public records
- Annual sales
- Invoice activity
- Credit limits
- Any legal judgements
- Debt recovery activities
- Overall credit score
The report can be quite extensive and the overall credit score is a measure of the business’s overall financial stability. It can also be used to predict just how likely a company is to pay your invoices, and on time.
It should be remembered, however, that credit reports are based on details from a snapshot in time, which is not always immediately obvious to the reader. Any company using credit reports need to be aware that the information could be several months old, perhaps even up to as much as a year.
Because these snapshots could be a little dated, due diligence in obtaining reports from several services may be necessary. Does this make credit reports any less important for your financial security? Not by any means, because used correctly they can be very helpful in determining creditworthiness and can help negate the need for a debt recovery service in the future.
What is a debt-to-income ratio?
Another excellent way to determine the creditworthiness of a company is to use the company’s financial statement as well as a credit report. To ascertain the debt-to-income ratio of the business. Nearly all businesses have ‘debt’ of some kind, whether it is trade credit or anything else. The debt-to-income ratio is a calculation of what portion of any debt, in total, make up the total earnings.
The calculation itself is quite simple; all you need to do is divide monthly debt payments by gross monthly income then multiply by 100. Of course, the lower the number that you come to, the better – ideally below 36.
Business credit reports are always going to be useful, as are financial reports (businesses looking for credit with you should have no issues in providing one), in managing the risks to your business.
Used correctly, credit reports could be the difference between you taking on bad credit and establishing flourishing relationships with new customers.