Magazine article Business Credit

Credit Scoring: Why Some Do and Some Don't

Magazine article Business Credit

Credit Scoring: Why Some Do and Some Don't

Article excerpt

In the beginning, when credit scoring first became part of the B2B credit lexicon, it was, in many circles, framed as the harbinger of doom for the traditionally fluid nature of the business. Fears arose that it would erode the "human element" that so characterizes a profession where finding a way to make sales that are patently illogical is the only way to find success. As years have passed and this complete mechanization of the credit function has yet to take place, attitudes have, for the most part, changed and credit scoring now acts as something of a technological luxury for some and a necessary efficiency for others. Interestingly enough, and as indicated by the comments received from NACM's July monthly survey on credit scoring, the diversity in the B2B credit world has necessitated both credit scoring's adoption and its rejection.

Weeding Out

The aforementioned NACM survey asked, "Do you use a proprietary credit scoring system in your day-to-day evaluation of accounts?" with 67.8% of respondents replying "no" and the remaining 32.2% answering "yes" Of the respondents who said yes, a commonly used refrain was that the credit score was only a piece to the credit investigation puzzle. One respondent noted that, in their company, credit scoring was used "not as an absolute, but it is a factor," with another remarking that "it is just one part of the evaluation process." Other respondents noted that their own credit scoring system was used in different capacities depending on the type of account. "For new accounts, the system is based on a set of varying 'if ... then ...' scenarios, rather than a traditional point score," said one respondent. "For existing accounts, we have an automated credit check based on credit limit, a risk category and relative percentages of past-due amounts and total exposure."

The prevailing wisdom regarding credit scoring was that the many companies that use it do so to weed through the accounts that don't need all that much attention. These would be the accounts that exist in the extremes: customers that are an extremely low risk and customers that are an extremely high risk. This method allows for the commingling of technology and credit expertise, where one strengthens the other, and while it isn't the case for all credit scoring users across the board, it is a philosophy that allows a credit department to focus its energy on the accounts that might not be so easy to approve or deny, rather than spending time on the no-brainers.

Other potential uses are varied. Some users noted that they use it to "drive collection efforts" where certain customers with a certain score who've gone delinquent can be ranked and efforts can be focused where they'd be most effective. One survey participant noted that their company uses a credit scoring system only for accounts on a pre-approved list. "All others are manually reviewed and decisioned by a group of analysts," they said. "We found that most of the business we tried to score in an automated fashion by one of the reporting vendors came back as 'needs further review,' so we just do it ourselves now." Another participant noted that their scoring has been very reliable in terms of predicting future non-payment or default problems. "Our scoring system has been very effective," they said. "Virtually all of our customer failures have been from the lowest quintile of our scored customers."


Reasons Why

Just as the uses of credit scoring are varied, so too are the reasons why companies choose to use it. "A reduction in time" and "increased efficiency" are two of the most frequently given answers to the question of why companies implement their own credit scoring model, but in following up with many survey participants, a number of other reasons cropped up. Some reasons that were expected to be popular were surprisingly scarce. "[The] Sarbanes-Oxley [Act] (SOX) was a major motivating factor in using a credit-scoring model," said one respondent, who wound up in the minority of respondents who did use their own proprietary scoring system. …

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