In the fast-paced world of business, a steady stream of cash flow is the oxygen that keeps your company breathing. But what happens when customer payments slow down, or unexpected credit risks emerge? This is where credit analysis becomes especially important and an area that shouldn’t be overlooked.
Credit Analysis: Beyond the Credit Score
Credit analysis dives deeper than just a simple credit score. It’s a comprehensive evaluation of a customer’s financial health, providing valuable insights that empower you to make informed decisions regarding credit terms and limits. Here are four key areas to focus on during a credit analysis that I have found helpful over the past 10 years working in corporate accounting.
Customer Creditworthiness: Examining Payment History
A customer’s past behavior is often the best predictor of future performance. Analyzing their payment history allows you to assess their creditworthiness. A history of late payments or defaults indicates a higher risk of potential delinquencies in the future. This information helps you establish appropriate credit terms (e.g., shorter payment cycles, higher down payments) for higher-risk customers, mitigating the risk of bad debt and potential cash flow disruptions.
This is where locking into multi-year contract deals become very important when conducting this analysis. You do not want to put your business in a position where you cannot get out of extending longer terms to a customer who struggles to pay.
On the flip side, a consistent record of on-time payments demonstrates a customer’s reliability and financial responsibility. This allows you to offer favorable credit terms (e.g., extended payment cycles, higher credit limits) to reward these valuable customers, potentially boosting sales and strengthening customer loyalty.
Beyond the Numbers: Evaluating Sales/Revenue Performance
Financial health isn’t just about past payments; a customer’s sales and revenue trends paint a vital picture of their future ability to meet financial obligations. Analyzing their sales performance can reveal potential red flags. A declining sales trend might indicate financial difficulties that could impact their ability to make timely payments. By identifying such trends early on, you can adjust credit limits or payment terms proactively to minimize risk and protect your cash flow.
However, a strong sales performance can also be a positive indicator. Understanding a customer’s growth trajectory allows you to extend higher credit limits with greater confidence, potentially facilitating larger orders and strengthening your business relationship.
This is why it’s so important that your AR/Collections team be PROACTIVE when it comes to managing the collections process.
Click the image below to read more where I speak on why a proactive approach is the best way for your company to manage getting paid.
Building Bridges: Analyzing Customer Communication and Collaboration
Credit analysis isn’t just about numbers; it’s also about relationships. Assessing how well a customer communicates and collaborates with your finance team can provide valuable insights into their overall reliability. Do they respond promptly to inquiries? Are they proactive in resolving any payment issues? Do you work directly with someone making payment decisions or are you routed to another team that is a roadblock to getting you paid? These are all super important questions to consider.
Effective communication fosters a positive business relationship. Customers who are open and transparent with your finance team are more likely to honor their payment commitments and collaborate to find solutions in case of any unforeseen challenges. This fosters trust and minimizes the potential for cash flow disruptions.
Schedule Regular Check-Ins: Keeping Your Cash Flow Compass Calibrated
Just like a car needs regular maintenance, your credit analysis practices need consistent attention. Don’t wait for warning signs to appear before you reassess your customers’ creditworthiness. Schedule regular credit check-ins (e.g., bi-annually or annually) to ensure your credit limits and terms remain aligned with each customer’s evolving financial situation and performance.
Listen in to this video we put together a while back to help you understand more about credit checks! While there, subscribe!
By incorporating these key elements into your credit analysis practices, you gain a comprehensive understanding of your customers’ financial health. This empowers you to manage cash flow effectively, minimize bad debt risk, and ultimately, secure a stronger financial future for your business. Remember, PROACTIVE credit analysis is your key to a steady cash flow and a business that thrives.
Last week’s newsletter we discussed cash planning and wanted to share with you another personal blog that may help you out when it comes to managing personal finances while also managing kiddos! Read more through the link below and join their community to gain valuable insights! #knockedupmoney #newsletter #blogging
