Protect Yourself From the Four Most Disruptive Credit Risks

Underestimating credit risk can turn a healthy business upside down quickly, so there’s a lot riding on your ability to minimize your exposure. When it comes to assessing risk, looks can be deceiving. You’ve heard stories of customers who looked big and sounded solid but ended up being insolvent—causing a nightmare for the companies left holding their unpaid invoices.

Credit screening is the best way to minimize your credit risk and weed out applicants whose good first impressions may be covering financial flaws. But, there’s more to credit screening than collecting a credit application. Effective credit screening is a mix of science and art and is a skill you can hone with attention to a few key details.

Know the Four Key Credit Risks

When it comes to minimizing your exposure, you want to eliminate or mitigate the impact of these four most disruptive credit problems:

Bankruptcy: While some companies may be fine doing business with a customer who has a bankruptcy in his past, no one wants to be stuck holding the bag when a current customer goes under. Do you know the red flags that can help predict bankruptcy?

Slow Pay: Customers who chronically pay you 30 or 60 days late increase your risk and cost you money. Are you checking applicants’ payment history with other companies as a predictor of how they will pay you?

Disputes: Customers who consistently eat up your time and energy with disputes can also impact your bottom line. Do you know how to identify a customer who may be prone to this behavior before he becomes a customer?

Fraud: Fraud can turn a great sale into a major business loss. Do you have a way to vet applications and monitor customer purchases to help identify potential fraud?

Use Your Risk Assessment Toolkit

So how do you identify the potential for these risks in credit applicants? There are lots of tools available to help you identify and manage potential risk that you otherwise might not have visibility into. A good place to start is to pull commercial and consumer

A good place to start is to pull commercial and consumer credit bureau data for both the company and its owner. This information will tell you how well this business and individual pay bills, as well as allow you to gauge stability and see payment trends. Where there is conflicting information—for example, strong business credit but a more checkered individual rating—dig deeper to better understand your potential customer.

If commercial credit bureau data is thin or non-existent—which is not unusual for a small or new business or single proprietor—then you’ll have to rely on consumer credit bureau data. Some companies may skip this step and just secure a personal guarantee, but this isn’t a good idea. A personal guarantee is only as good as a person’s ability to pay, and that’s what you’re looking for in their credit bureau information.

Your next tools are bank and trade references. Ask for 1-2 bank references and 3-4 trade references, and follow up on them all. Look at the length of relationship with each of the references—you want to talk to banks and companies that have a history with the applicant, not ones that are all new.

Look for references that have extended comparable or larger credit and similar terms to what the customer is seeking from you. If you have a customer asking for a $35,000 line, you want to understand whether he’s previously handled this level of loan, as well as what cash balances he has on hand. Also pay attention to his payment terms for that line and whether he met that obligation.

Be sure to have a conversation with trade references about what type of customer an applicant has been. Ask about disputes around deliveries or quality and find out if he’s been a reasonable and good partner. Chances are, he’s going to treat you the same way he’s treated other companies.

Google and public record searches can provide a wealth of information that can, directly and indirectly, tell you a lot about an individual or
company. You should consider this kind of research a must before you sign off on any sizable credit line. A quick search can uncover both positive and negative information about the applicant:

  • Active or past lawsuits, liens or other legal activity
  • Press coverage of company and its owners
  • Support of community and trade initiatives

Lastly, don’t forget the importance of getting the word on the street—especially in small markets or for new businesses looking for credit. At the end of the day, your credit screening should be based on solid information rather than a rubber stamp approach.

Mitigate Risk Before It Hits

The next step in credit screening is to assess all your information, looking for signs of the four key credit risks: bankruptcy, slow pay, disputes and fraud. The screening process used by many professional credit management services offers some rules-of-thumb that can help you in your assessment.

Bankruptcy: Proceed with caution when extending credit to new companies. Applicants with FICO scores <685 should also be watched, along with those who are bumping the limits of their lines of credit with the bank and other companies.

Slow Pay: If a customer pays slowly with other companies and vendors, chances are he’ll be slow with you. If this trend exists, set credit lines and terms that protect you, and use pricing and fees to help reduce the impact of slow payment on your bottom line.

Disputes: When trade references uncover a tendency to dispute invoices, return merchandise or chronically complain about products and services, think long and hard about whether this customer will be worth the effort.

Fraud: Believe it or not, the perfectly filled-out application can be a big warning sign of potential fraud. Look for these red flags on a credit application:

  • The company claims sizable revenue but doesn’t show up in commercial
  • The company claims sizable revenue but doesn’t show up in commercial credit bureau reports
  • The company is located far away—why are they buying from you?Generic email addresses, such as
  • Generic email addresses, such as info@abc.comReferences are typed and not on bank letterhead
  • References are typed and not on bank letterhead
  • Immediate responses from references

Stay Vigilant

Credit screening is not a one-time activity. Once you’ve set a customer’s credit line and terms, you need to pay attention to their purchasing and payment patterns. With new customers, make sure you follow up to see if they bought what they said they were going to buy and paid when they said they would. If they didn’t, talk to them and understand why.

An existing customer who always uses 20% of his credit line comes in and unexpectedly uses 100% of his line. Did you notice and do you know why? This change, combined with slow pay, could signal that the customer is in trouble.

Maybe you have a new customer open a line and immediately maxes it out in an online purchase for computers and electronics. Are you sure you know they are who they say they are and are not fraudsters buying hot items to resell and leave you holding the bill?

In addition to monitoring buying and payment trends, pull a new credit report on existing customers every year or two. The information provided by a fresh credit report can give you a full picture of a customer’s current credit worthiness.

“Trust but verify” is a good motto to keep in mind as you follow your credit screening process. In addition to collecting information, you really need to review it closely and ask yourself—does this seem reasonable? With this approach, you’ll be in a good position to minimize your credit risk and focus on growing sales.

Interested in learning more?
Check out our 10 insider tips on credit screening