December 14, 2023

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.”

NACM’s Credit Congress & Exposition is an annual conference established to bring credit professionals together from across the nation to network, learn about various topics in the credit industry and stay informed about the latest changes in the B2B credit world. But with the abundance of educational programs and professional growth opportunities, it can be challenging to know where to start—especially if it’s your first time.

Follow the NACM Career Roadmap

Credit managers can start their education strategy with the NACM career roadmap, which enables you to assess your professional accomplishments where points are awarded for both formal and continuing education, work experience, participation with your local and national NACM offices, as well as special activities in which you may be involved. Ronald Sereika, CCE, director of credit and client payment solutions at Mspark, Inc. (Helena, AL) earned enough points after completing his career roadmap to take the Certified Credit Executive (CCE) exam at Credit Congress years ago. “When I came back, I made the NACM career roadmap a requirement for any employees who wanted to move forward,” he said. “Employees who do this show me that they understand the basic credit principles, bankruptcy and can review financial statements. It made it easier for me to choose who I was going to hire once I knew what their designation was.”

John Zummo, CCE, CICP, senior manager of industrial credit at PCS Admin USA Inc. (Nutrien) (Deerfield, IL), who attends Credit Congress every year, has earned both his CCE and CICP designations. “Credit Congress was a great avenue to obtain my required CEU units,” he said. “Pick classes that’ll be applicable for your day-to-day credit role and classes on credit subject areas that you may not be responsible for today but might in the near future such as credit and business law. Apply what you learned into your daily responsibilities and let your manager(s) know what you’ve learned at the conference and how it’s helped you in your department. This can lead to promotions and higher leadership positions.”

Attend Sessions That Most Benefit You and Your Company

Each educational session has a detailed description that indicates how it could help you grow as a credit professional and benefit the company. For example, a credit analyst would benefit from attending a financial statement analysis course or a bankruptcy session. A young leader might benefit more from various leadership-focused sessions.

Sereika suggests credit professionals should first look at what their role is and what they're currently doing and try to sit down with their boss to decide what educational sessions would be most helpful. “In order to express the importance of attending Credit Congress to your boss, take notes for each session and show what you’ve learned and the value of it for your company.”

It helps to look at the industry you're in and then gear your course selection to what will benefit you and your company’s practices. For example, if you're in construction credit, you’ll want to attend a session on mechanic’s lien laws. “No matter the sector you work in, learn as much as you can about the tools of the trade that will help you be the best credit manager fit for your company,” said Tracy Rosenbach, CCE, senior credit manager at Silgan Containers LLC (Toppenish, WA) whose company encourages her to attend Credit Congress. “I think education is vital for credit professionals. For those coming into the profession, take advantage of your local NACM affiliates, credit groups and attending Credit Congress offers many useful courses and networking opportunities.”

Select Sessions According to Your Level

Along with the certificate courses comes educational sessions that cover various topics from financial analysis and international trade to leadership and networking. Each session is labeled with its own level of difficulty so that participants know what to expect. “I really love that the topics are presented in different levels such as beginner, intermediate and advanced,” said Tracy Mitchell, AR senior team lead at Trinity Logistics (Seaford, DE) who attended Credit Congress for the first time last year. “So, if you're coming in and you're very new to credit, or if you're coming in and you've been in credit for years, you know you can really tailor your experience to your skill level.”

Don’t forget to experiment and attend a session or two that you find interesting! You will be able to fit in some educational sessions for personal enrichment. “The fact that Credit Congress spans several days just really opens up those opportunities to take sessions that you find personally interesting as well as balancing taking sessions that are going to be more relevant to things that you're experiencing in your own company right now and some sessions over both areas at the same time,” Mitchell said. “As far as monetary value, you can take that knowledge back to the office, build your own training space for your team and help the company reach its financial goals.”

As the credit world continues to evolve alongside automation and technological advancements, there are many benefits: easier ways to receive payments, communication with customers and all around efficiency. However, with innovation comes vulnerability. Technological advancements in the past decade have made fraud a much easier crime to commit in the credit industry, especially through email phishing, forged digital documents, identity theft and more. And fraudsters are continuing to find creative ways to get away with their scams.

The current rate of fraudulent activity has increased at an alarming rate in recent years. Data from the 2023 Veriff Identity Fraud Report showed a 31% increase in document fraud alone, with an 18% year-over-year increase globally. Although a recent eNews poll revealed 83% of credit professionals say less than 0.50% of their accounts receivable portfolio were lost this year due to fraud, 59% of credit professionals have experienced a customer fraudulently dispute a credit card charge and 44% have seen an increase in fraud attempts during the new customer setup process.

Identifying red flags of fraud in accounts receivable is crucial for businesses to prevent any financial losses and maintain financial operations. Here are a few significant red flags that may indicate the potential of fraud:

Sudden Increases in Orders

A random surge in order volume from a specific customer or changes in order patterns with no explanation can point to suspicious activity. “A new company that reaches out unsolicited to do a large volume of business immediately is more likely to occur if the products you sell, in the case of manufacturing, have high street value so they can be offloaded in the black market,” said NACM Economist Amy Crews Cutts, Ph.D., CBE. “The orders might start small to gain your trust, but within a few months they are asking for a large credit extension to support massive orders out of line with existing clients you have known for years.”

Changes in Contact Information

Another common sign of suspicious activity is abrupt changes in bank, email or personal information. Often overlooked, business email domains can tell you a lot about the legitimacy of a customer as well as any misspellings in email communications. Start with looking at the size of the customer you’re dealing with and how they are set up to purchase and deliver the product of goods that they’re working with.

“Because most companies we work with are through manufacturers and distributors, we’ve had situations where former employees have gone in under the guise of still representing the company,” said Harry McLaughlin, CICP, process improvement manager at Continental Tire the Americas, LLC (Fort Mill, SC). “When you’re looking at new accounts, if the application is completed and they’re using email addresses such as yahoo or aol other than their company domain, that’s typically the first warning sign. It can be an indicator of the size of the company but also how they structure themselves and how aware they are of their brand and exposure.”

Customer Becomes Unreachable

Customers who randomly disappear and come back at inconsistent times raise a red flag for many reasons. Several instances of payment delays or excuses can indicate financial distress. In some cases, customers may also switch their payment methods frequently, which points to signs of fraudulent activity. One early warning sign that a customer is about to cut off contact completely is if you call your customer and they screen your calls, which means they let the call go straight to voicemail. “Nine times out of 10, if your customer is screening calls, they are doing that with all phone calls, not just yours,” said Kevin Stinner, CCE, CCRA, credit manager at J.R. Simplot Company (Loveland, CO). “It’s a red flag that they have multiple creditors contacting them and you’re not the only one they’re avoiding.”

Create a Strong Fraud Defense System

Avoiding falling victim to fraud starts with excellent compliance practices. It ties back to knowing your customer and being one step ahead. Whether a big or small company, exposure to fraud is equally present and can happen both externally and internally.

31% of business fraud is perpetuated by someone on the inside, according to a KPMG 2022 Fraud Outlook Survey. Training and a work culture that rewards employees for looking out for the company's interests is necessary for success in fighting fraud and other threats, explained Cutts. “It requires a culture of compliance and training. Businesses rarely change banks because it involves a lot of transition costs,” Cutts said. “But in the rare cases they do, the credit department, treasury officer, and sales team will all have gone through training on the new payment system and customer communication. If you have a client asking whether your company has changed banks, your sales team and your credit managers should know what to do to prevent the fraudster from getting paid with your money.”

Some credit professionals use built-in fraud check verification processes during the new account setup. Vimal Patel, CBF, regional credit manager at OneSource Distributors, LLC (Oceanside, CA) said he no longer gives out their company’s full wire instructions in writing. “We give the instructions partially and customers and vendors have to call for the remaining portion,” he added. “We run a daily credit card report that is sent out to all our sales managers and their respective operations managers so they can review and flag any potential fraud transactions before we ship out the material.”

The Economic Impact

Fraud plays an important role in economic activity in two main aspects: The cost of losses and cost of prevention. It can be costly to invest in services to mitigate fraud and stay ahead of fraudsters, and the amount of loss (potentially leading to bankruptcy) can have an impact on the economy.

“The totality of those costs is an opportunity lost to invest in your company, compensate your employees better, or reward your investors,” said Cutts. “By not investing today in productivity enhancing technology or new R&D, you will always be behind where you want to be. It's an immeasurable cost, but a very high one.”

It is unclear what Chairman Sherrod Brown hoped to achieve when he convened a hearing with the eight CEOs of the largest banking institutions in the U.S. on Wednesday, Dec. 6. What he got wasn’t hard to predict—a well-choreographed lobbying campaign against the proposed Basel III ‘Endgame’ regulations that are set to be finalized next year. While Chairman Brown and a few Democrats tried to defend the new regulations, the coordinated attack from sympathetic Republican Senators was echoed by every single CEO testifying and dominated Wednesday’s hearing.

An obscure international standard setting Committee, the Basel Committee on Banking Supervision–named after Basel, Switzerland where the group meets—was established in 1975 in response to currency and bank failures that shocked the global economic market. Its mission is to help protect global financial market stability by identifying and suggesting a standardized regulatory and supervisory regime for national regulatory to consider and adopt.

Basel III Endgame is the final wave of regulatory changes across the U.S. financial system that are intended to bring U.S. regulations in line with Basel III recommendations. The most talked about aspects of the proposed regulations include increased capital requirements for large banks, with the amount of that increase being dependent on the “riskiness” of its business portfolio. On average, it is expected to require banks to hold 15-20% more capital.

The message from the banking industry is unanimous—increased capital requirements will result in higher interest rates for consumers and less access to consumer and small business credit. No one argues that this is a natural result of forcing banks to hold more cash. What is in debate is just how much. Proponents of the rule say that it will increase interest rates by an average of .03%. Opponents say that this is just a guess and that comprehensive economic analyses have not been conducted on the actual impacts of implementing Basel III Endgame as written; they argue that the real impacts on consumers will be much more severe.

The timing on this proposal couldn’t be worse. Consumer confidence in the economy is still low, with most consumers believing that there will be a recession within the next year. Interest rates are still very high and while inflation is back down to around 3.1% year-over-year, consumers are still reeling from price increases as a result of last year’s 7-8% inflation rates.

Opponents of the Basel III Endgame regulations are leveraging this public sentiment to generate significant opposition to the rule through a robust lobbying and public affairs campaign. While regulators have the recent failures of SVB and First Republic on their side, it’s highly unlikely that the regulations could have saved either bank, and opponents are quick to point that out.

During the hearing, Chairman Sherrod Brown, a Democrat, asked the CEOs whether they would be unable to meet the capital requirements of Basel III through a show of hands, to which not a single CEO raised their hand. He concluded based on this that clearly banks are capable of meeting the requirements, that they are not onerous, and that banks are just trying to protect their bottom line.

Later on, after calling out how one-sided it is to ask witnesses to answer questions with just the raising of a hand, Senator Rounds (R-SD) asked the CEOs to do the same to his series of questions. He asked whether the proposed Basel III regulations could negatively impact: first time homebuyers, those saving for retirement, farmers and ranchers, and small business owners. In each instance, the witnesses all raised their hands. Of course, none of those answers really meant anything either, as each question was posed as a ‘could’.

All-in-all, pretty typical for a hearing on Capitol Hill.

Next year officially marks the beginning of the 2024 Presidential elections at a time when Democrats are on defense on economic issues. Given all of this, it is hard to see the Basel III Endgame regulations implemented in the same form in which they were proposed earlier this year. Even if they are, we probably won’t see the economic impacts of the new regulations for several years, as the proposed regulations already include a 3-year phased implementation schedule.

In closing, while we wait for the chips to fall, despite rhetoric on both sides, it is hard to see any immediate or even short-term impacts of the new regulations within the next year or two. Where the impacts may be felt are in the event of a recession several years down the line and banks find themselves less well capitalized leading to consumers and small businesses seeing their lending products eliminated or more expensive as a result.