Credit risk is a crucial factor for small and medium-sized enterprises (SMEs). Managing credit risk effectively can increase financial stability and improve cash flow and overall business growth.
In fact, according to data gathered by Allianz, managing credit risk was identified as one of the top priorities for SMEs.
In this guide, we will focus on five strategies and tools that SMEs can implement to reduce credit risk. We will also discuss how advancements in artificial intelligence (AI) have made it possible to manage credit risk more efficiently and effectively and how SMEs can leverage these technologies.
1. Credit check customers before and during working with them
One of the most effective ways to reduce credit risk is by conducting thorough credit checks on potential customers before extending credit to them. This includes checking their credit history, payment records, and overall financial stability. By doing so, you can identify any red flags or warning signs that could indicate a higher risk of non-payment.
But credit checks shouldn't just be a one-time process. It's crucial to regularly monitor your customers' creditworthiness and financial stability, especially if you have an ongoing business relationship with them. This allows you to identify any changes in their financial situation that could increase the risk of defaulting on payments.
When conducting a credit check, reliable data sources are critical. Credit reporting agencies such as Experian and Equifax provide comprehensive credit reports for businesses. These reports include information on a company's financial history, payment records, and any outstanding debts.
Tools such as Chaser's credit-checking feature also allow you to set up credit monitoring alerts for your customers so that you can stay updated on any changes in their creditworthiness.
2. Set credit limits for effective risk management
Credit limits play a foundational role in credit risk management. By setting limits for each customer, you can minimize the financial impact of potential non-payments and manage cash flow more effectively.
Using tools like Chaser empowers SMEs to set and manage customer credit limits automatically. This way, you can ensure that credit limits are set consistently and accurately according to your risk appetite.
The key to setting effective credit limits is finding the balance between providing enough credit to support your customers' needs while protecting your business from excessive risk. Consider factors like a company's size, industry, and payment history when determining credit limits.
Some of the common factors that can help determine credit limits include:
- Industry benchmarks - researching credit limits set by other businesses in your industry can give you a benchmark to start from.
- Payment terms - if a customer consistently pays late, it may be worth reducing their credit limit to minimize the risk of non-payment.
- Credit score and financial stability - higher credit scores and stronger financial stability may warrant a higher credit limit.
- Payment history from credit checks - by monitoring customer payment history, you can adjust credit limits accordingly.
- Customer's ability to provide collateral or personal guarantees - for higher-risk customers, requesting collateral or personal guarantees can provide added security.
By setting appropriate credit limits, you can ensure that your business is protected from potential losses while still maintaining good relationships with your customers.
To cut down on the resources and staff time needed to implement credit limits for each customer, consider using AI-powered credit risk assessment tools. These solutions can analyze vast amounts of data to provide accurate recommendations for credit limits that are tailored to each customer's unique financial situation.
Chaser's payer ratings system uses customers’ previous payment behavior and compares trends seen across Chaser, assigning every payer an AI-generated ‘rating.’ These ratings, split into good, bad, and average, are easy to understand and can help you set credit limits for new and existing customers.
The speed and simplicity of this system allows SMEs to assess risk and make credit decisions quickly, ultimately improving cash flow and reducing the time and effort required to manage credit risks.
3. Use AI to predict how your customer will pay you
In addition to assessing credit risks, AI can also help predict how your customers will pay you. By analyzing vast amounts of data and patterns in payment behavior, AI-powered solutions can provide accurate predictions on when customers are likely to pay and if they are at risk of delaying or defaulting on payments.
This information is invaluable for SMEs as it allows them to proactively manage their cash flow and take necessary steps to prevent late or non-payments.
For example, if a customer is predicted to be at risk of delaying payment, you can reach out to them in advance to remind them of the upcoming due date or arrange an alternative payment plan.
Tools like Chaser's late payment predictor use AI algorithms to forecast payment dates based on historical data and customer trends, assigning a percentage score out of 100 to indicate the likelihood of late payment.
This allows SMEs to proactively manage their cash flow, improve financial planning, and minimize the risk of late or non-payments without having to spend hours analyzing data manually.
4. Ask for partial payments upfront
Asking for partial payments upfront is another effective way to minimize credit risks. By requesting a portion of the payment before providing goods or services, you are reducing the amount at risk if the customer fails to pay in full.
This approach is especially useful for new customers or higher-risk ones identified during credit checks. It also helps establish trust and shows that your business takes credit risks seriously.
Open and honest communication is usually the best way to negotiate partial payments. Explain the reasoning behind your decision and how it can benefit both parties. Offering discounts for upfront payments can also incentivize customers to pay in advance.
Some tips on how to effectively negotiate partial payments include:
- Clearly outline the terms of the agreement - specify the amount, payment date(s), and any applicable discounts or penalties. This will prevent misunderstandings or disputes later on.
- Be transparent and upfront about your intentions - explain why you are asking for partial payment and how it can help both parties. This establishes trust and sets a positive tone for the negotiation.
- Consider alternative options if the customer is unable to pay upfront - this could include setting up a payment plan or requesting collateral or personal guarantees in place of a partial payment.
- Follow up regularly and maintain open communication - this shows that you are serious about receiving the payment and allows for any adjustments to be made if necessary.
- Remain polite and professional - even if the customer is unable to meet your requests, always remain respectful and maintain a professional attitude. Good customer relationships are essential for business success and should not be jeopardized by disagreements over payments.
- Explain how this approach benefits both parties - by asking for partial payments upfront, you are reducing the risk for your business while also helping customers manage their cash flow and budget effectively.
- Offer incentives or discounts - to encourage customers to make partial payments, consider offering discounts or other incentives as a way to show appreciation for their cooperation.
Using down payments or partial payments can also help SMEs manage cash flow and reduce the impact of potential credit risks. Tools like Chaser's payment plans make it easy to set up and manage partial payments with customers, allowing for more flexibility in payment terms while still protecting your business from excessive risk.
How to reduce your business’ credit risk
Credit risk management is an ongoing process that involves continuously monitoring and adjusting credit limits, evaluating new customers, and proactively managing cash flow. By utilizing AI-powered solutions and implementing strategies such as setting appropriate credit limits and requesting partial payments upfront, SMEs can effectively reduce the risk of late or non-payments and maintain a healthy cash flow.
In addition to these measures, it is also essential to maintain open and transparent communication with customers. This includes providing clear terms and payment expectations, as well as promptly addressing any late or non-payment issues.
The strategies and tools mentioned above can help SMEs navigate the complex world of credit risks and protect their business from potential losses. By taking advantage of the benefits offered by AI and implementing effective credit risk management practices, SMEs can focus on growing their business with confidence and peace of mind.
To learn more about how Chaser can help your business manage credit risks and improve cash flow, request a demo with a credit control expert or start your no-obligation 14-day free trial today.
