A Complete Guide To Creditworthiness

Introduction

Selling on credit can boost sales, but it also carries the risk of late or missed payments. So, what can businesses do to protect themselves from potential losses? The key is to assess their customers’ creditworthiness.

By evaluating a customer’s financial history, payment patterns, and liquidity, you can avoid unnecessary risks. But how do you determine a customer’s creditworthiness effectively? Read on to find out.

What Is Creditworthiness?

Creditworthiness refers to the process of evaluating how likely a customer will default on their payment obligations. It is critical for businesses as it helps assess customers’ financial reliability before deciding on payment terms and determining whether they should be allowed to purchase on credit.

Assessing creditworthiness relies on two factors. One is measured by a customer’s credit score, a three-digit number based on the insights in their credit report. A high credit score means a customer’s creditworthiness is high, and vice versa. The second factor involves payment history. Your business won’t like to extend credit to a customer who shows delayed or missed payments or financial instability. 

Why Assessing Customer’s Creditworthiness Is Crucial?

Assessing creditworthiness helps you gauge the credit risk when selling on credit, guiding your decisions on whether to extend credit and under what terms. A good credit score allows for more flexible payment terms, while a poor score signals financial instability, prompting stricter terms to protect cash flow and reduce bad debts. Creditworthiness is essential because it:

• Gauges the risk of extending credit, safeguarding against financial losses from missed or late payments.
• Manages cash flows by predicting payment timelines and minimizing delays.
• Tailors credit terms, interest rates, and limits to balance competitive offers with financial security.

What Are The Factors Determining Creditworthiness? 

Numerous factors determine a customer’s creditworthiness, including payment history, debt levels and credit utilization, credit history, credit management trends, financial statements, trade references, etc. As customer’s earnings improve, they can more effectively manage their credit and ensure timely payments.

• Credit history reflects how a customer has managed their credit in the past. A history of timely payments generally indicates a lower risk. 
• Financial statements to assess your customer’s overall financial health, profitability.
• Credit scores like FICO or Vantage Score to check if customers have a higher credit score. It means they have a lower risk of non-payment and greater creditworthiness. 
• Debt levels and credit utilization helps check if existing debt or credit is being paid and how well a customer can handle new debt or credit in the current financial situation.
• Trade references to gather insights from other businesses that have previously extended credit to the customer and get practical feedback on a customer’s payment history. 
• Payment history to find out if a customer is able to settle financial obligations and is trustworthy and capable of managing new credit.

How To Determine Creditworthiness Of A Customer?

Before granting credit, a company should assess the customer’s competence to manage and repay outstanding debts. Here are six ways to determine the creditworthiness of a potential customer.

1. Collect relevant details to extend credit

Before extending credit, it’s crucial to ask customers to complete a business credit application form, which includes general business information, bank references, credit history, and more. These details help consolidate client data, expediting the customer onboarding process.

2. Check credit reports

A credit report contains information on the company and its financials, enabling you to generate credit scores. It depicts a company’s capacity to pay by tracking its payment history and public records. Credit reports of a company are available for purchase from credit reporting agencies such as Experian, D&B, and Equifax.

3. Assess financial reports

The financial report of a company provides insights into its cash position. Financial reports include the cash flow statement, income statement, and the balance sheet of the company. The financial health of a new customer should be examined thoroughly by reviewing their public financial statements.

4. Evaluate the debt-to-income ratio

Another way to evaluate the business credit risk of a customer is by examining their debt-to-income ratio. This ratio provides insights into how much of their monthly income is allocated towards debt repayment. Calculate the ratio by dividing monthly debt payments by gross monthly income. A low DTI ratio indicates a healthy balance between debt and income, whereas a high DTI ratio shows that a client has more obligations than the monthly income.

5. Conduct credit investigation

You must use multiple sources to conduct further investigations to evaluate the business credit risk of a customer. These investigations usually includes checking:

• Customer background and history
• Credit policies
• Accounts receivable aging report
• Economic and political climate analysis
• Future business probability

6. Perform credit analysis

The last step is to get a comprehensive credit analysis of the customer accounts. Evaluate all trade references and apply credit analysis to predict the probability of default. Consider key financial metrics like profitability ratio, leverage ratio, and liquidity ratio. 

How To Monitor Creditworthiness?

The best way to monitor creditworthiness is to automate the data gathering process in your credit cloud. A robust and automated credit application software helps integrate with credit agencies and extract credit reports, provide real-time risk alert monitoring, aggregate public financials, provide credit scoring algorithms, etc. 

• Automate credit report gathering 

A good credit management software automates the gathering of credit reports from 35+ agencies like D&B, Experian, Equifax, CreditSafe, Graydon, etc. through robust credit agency integrations You can also maintain subscriptions with multiple agencies of your choice as the best provider may vary from region to region and industry to industry. 

For instance, it’s not possible to review a large national builder and a small contractor in the construction industry. While D&B will have good data on the national builder, it may not have nuanced reports on the small company. The CEO of a small construction company may use his/her own personal guarantee. Here, you would need to opt Experian to get the consumer rating on the CEO’s financial health. 

• Automate credit report data extraction

Features like automated credit review and decision solution helps you gain granular data from over 100 data points from a credit report. Each report contains multiple data points depending on the subscription. You can use a subset of these data points in their credit scoring algorithms.

For example, ‘Paydex’ is a score that is calculated by D&B based on a customer’s past payment performance. It is very similar to a FICO score used to evaluate a customer’s payment behavior. This value will be automatically captured by credit application software for you to use in credit scoring algorithms. 

• Get real-time risk alerts

Automating credit reviewing will help you continuously monitor any risk alerts or notifications from credit agencies and news sources. Your credit cloud will proactively monitor sources to identify upcoming major activities such as bankruptcy, merger & acquisition, etc.

For example, Bloomberg publishes an article about Company A acquiring Company B. This news gets picked up by the monitoring to trigger a credit evaluation of Company A and B as they are both your customers.

• Gather public financial data 

You can automate the extraction of financial statements from 15+ public sources like Edgar, S&P, BvD, Crefo, Graydon, etc. Public companies are required to publish your financials regularly. Leverage this data to get better insights into creditworthiness than relying solely on credit agencies. 

Similarly, you must derive financial ratios by letting your automated credit cloud calculate key ratios like Debt to Equity, Debt to Income, Current Ratio from the raw data points extracted from the financial documents. These derived ratios will further help assess your customer’s liquidity and get crucial inputs for credit scoring models. 

• Connectivity with trade associations 

Automated credit application software gives you out-of-the-box integrations with 10+ trade associations across various industries, including the national chemical credit association (NCCA), National Association of Credit Management (NACM), etc. Additionally, ensure to leverage granular data points from these information like Historical aging, Credit Limit Utilization from other members of the Trade Association, shared anonymously. 

Get Accurate Creditworthiness Analysis with HighRadius Credit Management Software

Achieving accurate creditworthiness analysis requires the right tools and integrations. Instead of custom-building a solution that could cost up to $670K and $200K annually for maintenance, HighRadius offers a cost-effective alternative with its Order to Cash software, featuring an automated credit cloud. This software integrates with multiple credit agencies, providing comprehensive credit data while reducing bad debt write-offs by 10-20%.

With built-in workflows, credit approvals are simplified—approve, reject, or reassign with just one click. HighRadius also uses a waterfall model to pull data from credit agencies efficiently, lowering the cost of reports. This lets you handle 3X more credit reviews while improving analyst productivity by 30%.

FAQs

How do you measure a company’s credit risk?

Measuring a company’s credit risk involves evaluating its financial health, reading financial statements, and gathering data from credit history, credit reports, and industry trends. Key indicators like credit rating, debt-to-equity ratio, and payment history are analyzed to assess the likelihood of default. 

What two factors determine a company’s level of credit risk?

The two main factors that determine a company’s credit risk are:

1. Payment history – Reviewing a company’s track record with other suppliers to assess consistency in meeting payment terms.
2. Credit scores – Analyzing credit scores, which typically range from 300 to 850, with higher scores indicating better creditworthiness.

What is the best measure of creditworthiness?

The best measure of creditworthiness is a thorough evaluation of the five Cs of credit: character, capacity, capital, collateral, and conditions. Considering these factors provides a comprehensive understanding of an individual or company’s creditworthiness, aiding lenders in making informed decisions.

What are the 5 C’s of creditworthiness?

The 5 Cs of credit risk analysis are Character, Capacity, Capital, Collateral, and Conditions. These components help businesses assess a customer’s creditworthiness by evaluating factors such as the customer’s reputation, ability to repay, financial assets, collateral offered, and the broader economic conditions that may impact payment reliability.

What are the main benefits of creditworthiness?

A strong creditworthiness or higher credit scores can help you:

• Establish credibility with suppliers and stakeholders
• Negotiate better payment terms with suppliers
• Stay competitive in the market
• Qualify for larger loan amounts
• Support major expenditures for business expansion
• Strengthen relationships with suppliers

Is a good credit score important to improve creditworthiness?

Yes, a good credit score is crucial for enhancing your creditworthiness, especially if a business wants to purchase or sell goods on credit. It indicates reliable credit management and timely repayments, making securing favorable credit terms easier and building strong business relationships.

How to improve creditworthiness?

Here are a few things that will help improve creditworthiness: 

• Maintain accurate financial records
• Enhance credit reporting practices
• Strengthen financial management
• Build strong relationships with credit partners
• Optimize credit management process
• Leverage credit insurance and guarantees