Magazine article Business Credit

Creating Value through Credit Risk Mitigation. (Selected Topic)

Magazine article Business Credit

Creating Value through Credit Risk Mitigation. (Selected Topic)

Article excerpt

Credit risk mitigation is a proactive management tool designed to enhance revenue growth (in good times and bad) while protecting earnings from surprising, catastrophic loss.

A prominent and wise CFO once said that a credit department serves the company best when bringing in revenue. To fulfill this mission, the credit department's critical ally is risk mitigation.

The nature of American business is changing, and each function--whether core or non-core--is expected to play a strategic role. Generating profitable revenue is at the heart of all strategic activities. It is possible to reduce unacceptable levels of risk from the revenue stream through proactive use of credit risk mitigation. While trade credit insurance is the most common method, other credit risk mitigation tools have worked their way into the mainstream.

Take a Strategic View

Before the credit department can take steps to mitigate credit risk, it is important to understand corporate strategy and corporate tolerance of credit risk. These two factors will affect the appropriate timing, size and type of a risk mitigation program. Working with the providers of credit risk mitigation products can generate ideas for proactive measures to limit credit risks and the cost of mitigation. To help produce a full revenue and profitability picture, the credit function should provide explicit input to sales and financial management on what risks can be mitigated, by what means, and at what cost.

To develop a credit risk mitigation plan, start by examining the following factors:

* Product line plans and economics--The company product line affects risk, and margins affect affordability of both risk and credit risk mitigation.

* Terms of sale and variability of transactions--The predictability of cash flow, distribution characteristics and individual customer variables are also key considerations. Earnings are put at risk by high variability and uncertainty. Credit risk mitigation can enhance predictability.

* Country/Market segment strategies and underlying conditions--This will tell you where you need to take action, what the priorities for expansion are and where to support existing revenue streams from changing circumstances. Industry and political considerations are equally important.

* Competition and competitive positioning--Try to determine what credit risk mitigation steps your competition has taken. Depending upon your trade sector, this may impact the availability of capacity.

* Growth goals and timing--Understand the plans with sufficient lead-time to have the right instruments and capacity in place to support the sales forecast.

* Risk tolerance--A solid understanding of risk tolerance will tell you whether and to what extent self-insurance is the right course and whether you need a mix of instruments for all or part of the corporate strategy. Credit scoring should explicitly consider the factors driving corporate risk tolerance. (See the articles on credit scoring in this issue pp. 18-23 and pp. 54-57.)

* A/R portfolio aging--Managing your accounts receivable proactively and aggressively is part of risk mitigation. For both insurers and lenders, keeping accounts current is critical. Take whatever steps are necessary to accomplish this. If internal resources are inadequate to cover all accounts, consider bringing in an outsourcing partner to help.

There are three watchwords for credit risk management and mitigation: explicit, proactive and prudent.

Lessons from Non-U.S. Entities

Historically, foreign-based firms have looked to trade credit insurance to mitigate the non-payment risk associated with their expansions into the U.S. market. This approach has worked in both high and low tech trade sectors. Clearly, risk is in the eye of the beholder. The nature of the market or country colors perception, and the tolerance of credit risk is impacted by the personality of the company itself and the activities of its business units. …

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