Trade credit teams play a crucial role in order to cash space. They are responsible for onboarding customers who are creditworthy to ensure that the organization gets paid and maintains a low threshold of bad debt. While assessing a customer’s credit risk, the credit teams often use the framework known as ‘the 5 Cs of Credit’.
Credit teams heavily focus on data-driven decisions, and the 5 Cs of credit are not an exception. Let us have a closer look at these five parameters:
As the term suggests, ‘Character’ analyzes the customer’s character as a borrower. This analysis aims to figure out whether the customer will pay back or there is a higher possibility of defaulting on the payments.
To analyze the ‘Character,’ credit professionals often consider the credit history of a customer. The credit teams extract credit reports, credit scores from popular credit bureaus such as D&B, Experian, Equifax to look into the customer’s payment history, trade references, legal records, bankruptcy records.
‘Capacity’ means whether the customer’s organization has enough funds to repay the supplier team. If the customer has been experiencing unstable cash flows, then the credit teams think twice before extending the line of credit.
When it comes to the investigation of cash flow stability, who could serve as an alternative to a bank? Credit teams add mandatory fields in their credit applications to extract information such as bank references and trade references. Both of these credit references vouch for the availability of funds and assures the credit team that the customer will be able to repay. Sometimes, credit teams also follow the news alerts to understand the customer’s financial position, acquisitions, employee stability, etc.
‘Collaterals’ are similar to the concept of a mortgage. Suppose the customer can provide a ‘Collateral’ such as a fixed asset, which increases the possibility of getting a higher credit line. Collaterals act as a parameter of assurance to the credit management teams.
Ideally, in an A/R world, credit teams demand ‘Collaterals’ from a high-risk customer.
Credit professionals often check for the total ‘Capital’ owned by a customer. Capital includes financial and non-financial assets, and the credit teams get this information through the public financial statements.
The credit teams review the macroeconomic conditions and consider them as ‘Conditions’. This means they run scrutiny of the country, the geopolitical situation, industry of the customer.
If you ask a credit manager, ‘How to assess the credit risk of a customer?’ Undoubtedly, the credit manager will use the reference of ‘5 Cs of Credit’. This is because the 5 Cs of credit form the foundational questionnaire or checklist to extend the credit limit.
Based on organizations, the parameters to assess a customer might vary; some credit teams choose 4Cs of credit while others choose 7Cs of credit.
Often, organizations use the 5 Cs to evaluate the credit risk of new customers. However, credit teams should continue assessing their existing customers to ensure a lower bad debt.
While assessing the existing portfolios, the credit teams encounter the following questions:
It’s a tricky decision indeed!
Credit teams should monitor their customer portfolios on a real-time basis to track any significant or minor fluctuations in their credit health. This will help credit teams to stay on top of critical customers – all they need to do is apply the 5Cs of credit while evaluating the credit risk.
The 6 Cs of credit include character, capacity, capital, collateral, conditions, and customer credit score.
The credit limit is the maximum amount of credit or the line of credit that supplier A/R teams extend to a customer after thorough analysis. Credit exposure is the maximum amount of funds that your organization can lose if your customer cannot pay.
Credit reporting bureaus are external credit agencies that generate credit reports and scores for customers across the globe. These reports, ratings help trade credit teams to conduct an objective credit risk analysis of the customer. Some credit reporting bureaus include D&B, Experian, Equifax, CreditSafe, CreditRiskMonitor.
HighRadius Credit Software automates the credit management process, enabling credit managers to make highly-accurate credit decisions 2X faster and enable faster customer onboarding with 4 primary components: configurable online credit application, customizable credit scoring engines, credit agency data aggregation engine, and collaborative credit management workflow. Along with that, there are a lot of key features that should definitely be explored some of which are online credit application, credit information aggregation, automated credit scoring & risk assessment, credit management workflows, approval workflows, and automated bank & trade reference checks. The result is faster customer onboarding, better internal collaboration, higher customer satisfaction, more targeted periodic reviews, and lower credit risk across the company’s customer portfolio.