Most business transactions in the United States and other industrialized countries are executed on open credit terms. Companies routinely sell their goods and services without securing any up-front guarantee that they will be paid for them.
Trillions of dollars are at risk.
You’d also think with so much money at stake there would be air-tight standards and controls in place to help make decisions about who is creditworthy and who is not. And you’d think the governing principles for these standards and controls would be set at the highest levels of an organization.
But the reality is that one year after the worst credit crisis in memory—a financial debacle in which the flow of credit came to a virtual halt, paralyzing the global economy—critical decisions about which corporate counterparties are creditworthy and on what terms are still being made in an ad hoc manner. And the standards for extending credit—and therefore managing risk—are still being made in the back office rather than the corner office where they belong.
As an executive who has spent most of his career analyzing credit and advising clients on how to manage credit risk, I continue to be amazed at how few world-class companies treat this vital function with the same seriousness and sophistication that they treat other mission-critical tasks. Major multi-national corporations that would never dream of doing without state-of-the-art systems for managing production, inventories and pricing, fail to protect their businesses by having a state-of-the-art system for managing credit risk.
When I go inside a company, too often what I find is credit decisions, with material consequences, are still being made by mid-level managers in the “credit department,” guided by little more than their own discretion. Checks and balances are accomplished through an unwieldy process of garnering co-signatories, a daisy-chain approach in which the next person on the list is likely to assume that the one before has done the due diligence.
There is a better way.
It begins by recognizing that credit policy needs to be made—in a formal and holistic manner—in the C-suite. Senior management needs to establish enterprise-wide parameters that address the most basic risk-management decisions. How much exposure to risk can our company tolerate? What metrics are being used to assess the financial health of our counter-parties? Is the enterprise looking at all the strategic counter-parties?
Risk comes from exposure not only to customers but vendors, suppliers, insurers as well as prospects in the pipeline. And risk can also come from within. There’s an old saying in the credit industry that ‘the louder the sales department yells the bigger the credit line.’ Management needs to send a strong message that credit lines need to be extended and withdrawn based on established discipline, not personal persuasion or relationships.
The next step is to make sure the professionals actually charged with crunching the numbers have the right tools available to them and have been adequately trained to use them. Credit-scoring software that automates the process of establishing creditworthiness has evolved enormously from its infancy and the best products now offer a menu of industry-specific financial metrics, many of which can be validated through correlation analysis.
At a time when companies are changing terms of payment—speeding up collection of cash and slowing down their own payments—it’s critical to know whether this is a sign of a healthy company trying to conserve cash or a distressed company playing for time. The technology exists to make this determination and it seems obvious that having it would be money well spent. But I have been surprised time and again by how hard it is for credit managers to get the resources they need to perform the vital task they have been asked to do.
I recently consulted with one division of a multinational company where it took nearly two years able to complete its annual credit reviews of its thousands of customers. This left the company chronically exposed to unknown levels of risk. After we developed a comprehensive credit-risk management solution for this company, it was not only able to review all of its customers in just four months, it also established an early-warning system to monitor risk. The process was so efficient that other divisions of the company adopted these practices, further centralizing the risk management function and producing more cost savings and risk mitigation.
Another multi-national client had a tedious credit review process that required 10 to 15 page write-ups for each one of their thousands of customers, which up to 10 executives then had to read and sign-off on if the credit line was more than $250,000. After introducing a new credit policy strategy and months of vetting the process to ensure good results, this company was able to streamline the process dramatically, reducing the time it took to produce reports and the size of the staff generating them, all while enhancing the credit quality.
There are a growing number of success stories out there like these. And they should become the rule, rather than the exception, if senior executives focus on the value and the necessity of treating credit risk management as a vital priority.
The tools and the know-how exist to protect large, complex organizations from unnecessary risk. Now it’s up to the decision-makers to decide it’s time to act.
Gerald R Delisle
Chief Executive Officer
Strategic Risk Management Partners
www.srmpartners.biz
Email –delislegr@srmpartners.biz
