Cash Management: Managing Credit Amid Rising Corporate Risk

Some ideas on how to manage customer credit in a volatile economic environment. 

With the ongoing debt crisis in the Euro zone and as a sluggish US economy struggles to avoid another recession, the  implications for what’s ailing the broader global economy is on everyone’s mind. For corporates one issue that stands out is the increased risk of default on bonds and other obligations. As for treasury departments that oversee customer credit, the impact of the sovereign debt crisis cannot be overlooked, whether you are a selling to a company on a frail European continent or to a domestic buyer within a wavering US economy. Granting credit in today’s uncertain environment is can be challenging if not downright perilous.

With this looming wall of worry in mind, below are some ideas on balancing the dual objectives of  supporting revenue growth while protecting the value of your company’s accounts receivables.

Increasing Default Risk. As partly evidenced by increasing credit default swap prices, corporate credit risk is on the rise, particularly for those companies at the bottom of the credit spectrum. The Financial Times  reports that credit portfolio managers “at banks, insurance companies and investment funds around the world have grown increasingly concerned about a rise in corporate defaults amid uncertainty surrounding the financial health of peripheral countries and banks in Europe, a new survey has shown.” 

Results from an International Association of Credit Portfolio Managers survey indicate that sixty-six percent of participants expect an increase in corporate defaults in Europe over the next year. As for the US, the results were inconclusive as to whether default rates would rise or stay the same. According to Fitch Ratings, just about all US defaulted issues in 2011 “originated from the very bottom of the rating scale – issues rated ‘CCC’ or lower – a pool currently $205 billion in size.”  Fitch estimates that the default rate “for the ‘CCC’ universe” will reach 4.6 percent for the year.

Regardless, of where the pressures are, US credit managers are aware that financial stress indicators are up and in this risky economic climate, are taking a second look as to their credit scoring and monitoring of customer exposures. As one manager of a $5bn US industrial company explained, “Credit is a right for US buyers, while in Europe it has to be earned.” So there is generally more exposure to US companies than to global customers who do not necessarily expect you to offer them a credit line in order to business.

When you manage a customer credit portfolio, you are basically managing the downside risk. As mentioned, below investment-grade quality has definitely shown more signs of distress than investment-grade default levels, but waiting to take action is not prudent.  “We have definitely seen an uptick in number of bankruptcies,” the credit manager said, “however, dollar figures have not been significant yet.”  A prolonged economic downturn , depending on the industry you are in, may change that.

Implications for Credit Management. Ongoing communications of allowable customer credit are important so that actions and strategy can be coordinated between the sales and credit teams and, ultimately, when the receivable is turned to cash. 

For instance, agreement on credit terms should be well-communicated so that sales can negotiate only within set policy parameters. Credit management should not be done in a vacuum but rather needs to be a fluid part of the order-to-cash process.  One large multi-national found that setting credit direction and philosophy within the company is best accomplished via a management committee consisting of  company stakeholders.  Strategic credit decisions on credit and key customers now include the CFO, treasurer, and sales personnel. 

Ideas for Smart Credit Control 

1. Parent company versus subsidiary – be sure payments are 100 percent guaranteed by the parent and not just a parent “in name.” If not, value subsidiary as a separate credit risk.
2. Use limited credit department resources wisely – streamline the review of less risky customers and have leveling approval based on risk parameters.
3. Stagger credit reviews based on credit grade (e.g. riskiest customers reviewed each order, speculative grade every two months, etc).
4. Industry comparisons – compare your company’s loss appetite with the industry; are you over exposed compared to your competitors?
5. Partner with credit risk provider and employ industry tools (e.g. DNBi and Credit Risk Monitor) that can automate decisions by factoring in payment history, stress indicators, market data etc.
6. Bankruptcy alert built into the process flow for expedited  and coordinated response from all areas.
7. Build internal partners – legal, sales and collection areas.
8. Credit lines should be valid up to a maximum of one year at the most. 
9. “Where does your company fit in the pie?” A certain level of credit may be “safe,” however raising that level you may be at an increased risk for payment from the same customer. As we know, financial statements do not tell the whole picture.  Balance sheets are a snapshot in time, and can be very limiting when it comes to understanding the ongoing ability of the company to meets its payments over the foreseeable future. A strong payment history is often a better indicator of whether a customer’s will pay you their obligations.

There is no doubt that as problems mount in Europe and the outlook for the US economy sours, outstanding receivables on your corporate balance sheet may be more at risk.  Use these smart practices to ensure that your future customer receivables become collectible cash.