How to Assess a Customer’s Creditworthiness

In B2B transactions, trade credit allows customers to purchase what they need and pay at a later date. It’s an effective way to make and collect on sales for businesses. Though it allows flexibility, the reality of extending a line of credit exposes any business to potential risk when lending to new customers. Determining creditworthiness of a customer is one of the basic, yet essential principles in credit—and reflects how likely a customer will pay back a line of credit. It’s an important assessment to make in the process of dealing with any customer, current or new. So, here’s how to assess your customer’s creditworthiness effectively.

The number one challenge credit professionals face when assessing creditworthiness of new customers is a lack of information provided by the customer (52%), followed by pressure to make a rushed decision (24%) and incomplete or unreliable data (14%), according to a recent NACM eNews poll.

One of the 5 Cs of credit is character. As a credit professional, using your judgment of your customer’s character and integrity is important in determining if they will pay their obligations. Take a look at their payment history, bank and trade references or letters of credit to use your discernment—and search for any red flags such as bankruptcy filings or litigation.

Credit professionals who work with smaller customers or new companies that have been in business less than a year are most likely to experience the challenge of limited information. “When you run credit reports on your customer, if they’re independent or privately owned, there’s a lot of limited or missing information as far as financial data goes,” said Mark Zavras, CICP, director of credit at Sub-Zero Group (Scottsdale, AZ). “We can all cross our T’s and dot our I’s from a due diligence point of view regarding paperwork, but you still need to establish that relationship with the customer. That’s the most important piece of the puzzle.”

Receiving references from reliable sources is another obstacle to limited customer information, opening the door to a higher level of risk. Dawn Collar, CBF, credit manager at Southern Plumbing & Heating Supply Corp. (Gloucester, VA) said many new customer applicants she has seen this year do not have any business credit report data, which puts the company in a vulnerable position. “The risk of these particular customers going past due and not paying is far more,” Collar said. “If a customer does agree to provide credit references but refuses to share any information as far as recent high credit, credit limits or rushes you to make a decision, it’s a pretty big red flag.”

Communication plays a key role in assessing credit. If a new customer has any gaps in the data they need to provide, credit professionals can discuss starting off with a flexible payment plan or terms for the customer to abide by for a short period of time to establish some sort of credit history. Practicing a more dynamic and adaptive credit risk assessment model and open communication with potential customers is beneficial for both credit managers and the customer. Even if credit is not extended to a new customer or current customer for any reason, being transparent with the customer is a good way to handle the interaction professionally. Positive interactions can also open the door for credit to possibly be extended in the future. It’s all about building trust between you and your customer and maintaining integrity with your department, procedures and team.

Some external factors such as economic uncertainty that cause market shifts or industry changes can have an impact on a customer’s financial state as well. “Having a flexible approach to credit assessment can help mitigate risks and make informed decisions in a rapidly changing environment,” said Scott Dunlap, director of credit and collections at Coleman Oil Co. (Lewiston, ID). “Regular monitoring and staying informed about changes in the customer’s financial condition and the external environment are crucial for managing credit risk proactively. Look for trends in DBT in comparison to other accounts in that industry.”

Knowing when a customer seems off is a mix between your gut feeling as a credit professional and the obvious red flags (i.e., a customer does not sign a personal guarantee, lacking professionalism or the ability to show accurate financial reports, bankruptcy filings, etc.). Talk to members of your local trade group to see what information or experience anyone else may have with the customer. “All of this brings us back to focusing on the core 5 Cs of credit,” said Collar. “The biggest thing I have learned over the years is if something in my gut is iffy about a customer and their application, you are normally right.”