The credit analysis

Prevention is better than cure. This maxim applies perfectly to credit management function. It is preferable to identify the risks of non-payment as early as possible rather than battling in costly litigation following unpaid debts.

Credit management is divided into two parts. First one is preventive about customer assessment and securing the payments, the second part is curative relative to cash collection and performance management (DSO, working capital ... etc.).

The second part is dependent on the first, which is fundamental for the success of the relationship seller / buyer from a financial point of view.

It is indeed during the trade negotiations that will be defined payment terms, any associated guarantees and contractual clauses.

The basis of preventing credit risk is to achieve a good credit analysis. This will highlight what are the risks in front of security tools or risk mitigation may be proposed.

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What is the credit analysis?

The credit analysis is an overall assessment of the current business relationship or the one which will come up with a client. It takes into account several additional elements.

About the buyer:

• Creditworthiness of the buyer with the completion of a financial analysis of its balance sheet and its income statement.
• Behavioral references of the buyer: does he meet with its commitments? What is its payment behavior?
• Commercial references of the buyer. Is he a business with great potential? Does he have a favorable market positioning? What is his age?
• Legal form of the company. Is it a private or public company?

About the environment of the buyer:

• Sector risk: is the customer part of a sector in crisis or with a strong increase of business? With the Covid-19 crisis, the impact is very different according to the sector, this has to be taken into account.
• Country risk: does the country of the buyer has a significant political risk that could affect the progress of the business case?
• Currency risk for export to a country which has another currency and if the contract is signed with the buyer's currency.

Regarding the advisability of sale for the seller:

• Is it a strategic business? What is the level of margin? Is it profitable from a cash point or view or does it contribute to increase the working capital?
• Is that the case is secured (documentary credit, credit insurance... etc.)?
• Is that the case engages a high part of financial resources of the seller? Does the risk of non-payment would threat the sustainability of the seller?
• Does the contract is balanced? What are the contractual risks and responsibilities of the seller (liability limit, termination clause... etc.)?

The credit analyst compiles this information and synthesize to get a "snapshot" of risks (weaknesses) and reinforcing elements (strengths) of the business opportunity.

He then offers solutions to make the risk acceptable in accordance with the risk management strategy of the company.

Purpose of credit analysis

Ultimately, the credit analysis leads to the set up of payment terms and payment guarantees that will be consistent with the credit limit allowed to the customer (if any). Another goal is to include into the sales contract clauses protecting the seller according to the risks identified.

Anticipation and intervention early in the sales process of the credit analyst is a key success factor. Then, he can identify risks and counter them with the appropriate tool.

Sales process

Credit analysis during Covid 19 crisis

The economic crisis following the Covid 19 health crisis is different from all those we have experienced before. Never whole swathes of the economy have been shut down brutally in modern history.

The first effect was to reduce economic activity by around 40%, with a very variable rate depending on the business sector. The building sector and several others fell by 90% while rare sectors such as digital or online commerce benefited of a certain stability or even an increase.

The suddenness of the crisis make a very strong and quick impact on companies.

Therefore, credit analysis must adapt and assess the financial capacity of the company to face successfully this situation.

We can see two main points:

• With the financial analysis, assess the resilience of your customers who may suffer a real black out of turnover.
• With the sector analysis and a cash forecast evaluation, assess the evolution of their cash.

Locate the credit analyst in the company

Depending on the size of the company, the credit analysis is performed by a qualified analyst, Credit Manager or a person trained belonging to the financial department (Chief Financial Officer, Accounting ... etc..). She / he is responsible for credit granted to customers and must be attached to the Finance Department. In large companies, she / he defers to the Credit Manager who negotiates with customers and sales managers and then ratify decisions based on credit analysis performed.