Credit Scoring in B2B Trade: Explained

Credit scores reflect how likely or unlikely a person is to pay any loaned amount of money back. Three digits, typically between the range of 300 to 850, can decide your fate in a multitude of purchases from vehicles to mortgages or student loans, for example. These scores are used by companies to determine the interest rates and credit limits you should receive.

But credit scoring is not limited to the consumer sector only. In the B2B environment, credit managers can also use scores to help gauge how much credit to extend and make credit decisions. Most professionals review a business’ credit score by running a credit report to get their rating. The report shows a clear picture of the business’ ability to pay their invoices based on payment history or public records—and other financial data such as credit limits over multiple years, collections activities and annual sales.

Consumer and business credit scores serve the same purpose, however, there is a difference in how each one uses credit scoring models. B2B relationships are often more complicated than B2C, so B2B credit managers must consider more than a credit score when making decisions.

Internal vs. External Credit Scoring

Most credit professionals review the credit score calculated by an external or third-party agency, such as NACM’s National Trade Credit Report—but others have an internal credit scoring system. Internal credit scoring models were first used by banks and credit card companies because of high volume in low-amount transactions in consumer credit. However, in commercial credit underwriting, the purpose of scoring models is to help build an overall view of a business and become a baseline for making credit decisions. Some businesses may not be big enough or have enough trade lines that can be reported into third-party tools to get an accurate rating in their credit score. In those cases, credit managers can include more credit reference checks and use different sources to get to a credit decision.

Yes, but: Like any other scoring system, there are potential flaws. A business’ credit score is only one piece of the puzzle. Some credit managers do not consider credit scoring at all—but others may rely too heavily on it. Finding the perfect balance in how much a credit score contributes to your decision in extending credit is an important skill to navigate with.

By the numbers: A recent eNews poll revealed that 33% of credit managers say credit scores contribute to nearly 75% of their credit decision. Conversely, 20% of credit managers do not use credit scoring at all.

Nate Yagle, vice president of credit at Premier Companies (Seymour, IN), said he approaches each line of business differently when it comes to credit scoring. For example, “In our heat division, we view that as a very transactional type of account, so we rarely use internal credit scoring systems,” Yagle said. “Instead, we use external bureaus for those credit decisions. For the agronomy side of business, we’ll look at bureau scores—but many trade lines are not reported to the bureaus when it comes to agriculture, so it makes it hard to have an accurate score for the farm itself and causes us to rely on additional metrics and resources to make our decision.”

Jessica Holt, director of credit and collections at Soligent Distribution (Dallas, TX), considers customer credit scores as 25% of her entire credit decision. “Several factors are taken into consideration, including credit reports, credit references, personal guarantees and financial statements, and we also consider sales opportunities and relationships,” Holt added. “We always review tax liens and any UCC filings to ensure we are aware of secured vendors and any impact that might bring to our decision instead of credit scores by themselves.”

Credit scoring strategies change depending on risk categories, industry, economy and time of year. “Credit scoring can be based off of trends in terms of placing larger orders toward the end of the year, beginning of the year or consistently, so those patterns are crucial,” said David Escobar, credit manager at Evapco, Inc. (Taneytown, MD). “Our credit decisions are weighted by 25%-50% of the credit score. We use credit scoring for both new and existing customers. With newer customers, we’re going to take a more thorough approach. With existing customers, they’ve already established a pattern so we can already see the payment history.”

Kristin Caswell, CBF, CICP, director of credit at Dakota Supply Group (Plymouth, MN), uses credit scores to make up 75% or more of her credit decisions. She said her department has two different scorecards: one for new customers and the other for existing ones. For new customers, Caswell considers factors like how long a customer has been in business, their response to bank and trade information and whether they signed a personal guarantee with their credit application. For existing customers, Caswell said she adds more weight to their relationship and payment habits, sales in the previous year and any losses with the customer.

“If there’s more than one person setting credit limits, it’s hard to be consistent across each customer,” Caswell said. “So, if a neutral and consistent credit limit setting is important to you, the credit scoring helps guide you down that path. There are situations where the scoring model doesn’t fit our particular customer or there are exceptions that need to be made or different information to be considered—and that’s where you make the exception outside of the scoring. I like credit scoring for the consistency factor.”

NACM’s National Trade Credit Report service provides a Portfolio Risk Analysis (PRA) tool, which is a platform consistently updated with new and refreshed data daily to help credit professionals understand changes within their customer portfolio. “It’s a way for us to upload members’ data files into our system and import that data back in a raw form,” said Gina Calabrese Sylvester, CMP, CGA, executive vice president of NACM Tampa (Tampa, FL). “You can import credit scores into your internal system and come out with an aggregated score to use or look at the number of trade lines that are on a report with some of your competitors.”

As a fully automated tool, you can also choose the frequency of use because it is subscription-based. The PRA tool provides credit managers with a better view of which customers are high-risk.

The bottom line: When in doubt, it is always a good idea to refer to the 5 Cs of credit to evaluate the creditworthiness of any customer. When taking credit scores into consideration, credit managers should know that scores based on up to year-old information are not a full reflection of the current and present developments of a customer’s creditworthiness. Combining credit reports with additional credit assessments is a great way to make a well-rounded credit decision.

If you’re interested in learning more about predictive scoring or the subscription models for the PRA, contact your participating NACM affiliate.