To understand what credit risk exposure is, we first need to understand exactly what credit risk itself is. Credit risk is the risk posed to a company if a third party client they loan to does not honor an agreement, usually the repayment of money. Credit risk exposure is the total and maximum amount of money you could lose if all your third party clients fail to honor their payment agreements. This credit exposure is often calculated in relation to specific types of agreements such as repayment loans or long-term contracts.
Understanding your credit exposure is part of risk management for your business. Once you have conducted an audit on your core operations and identified your default risk, you are able to take steps to ensure the security of your company and reduce your credit risk exposure.
Careful client selection is the first step in monitoring and reducing credit exposure risk. It is important to limit and lower your risk by conducting a credit analysis on potential clients prior to selection. Look for clients with higher credit ratings as they will be more likely to uphold their agreement and repay the loan. This does not mean that you should not take on clients with low or no credit rating, rather use this information to tailor the loan agreements you offer to them.
Controlling Credit Exposure
Controlling your credit risk exposure is critical, especially now in such uncertain economic times. A common way to reduce risk is to introduce penalties and new loans with a higher interest rate. These measures aim to deter clients from missing a payment and mitigate the loss that may arise from a potential missed payment. This particular method is often utilised by banks, however there are a number of other ways lenders can control their risk exposure.
Setting credit card limits or altering the principle and interest amount based on the clients expected likelihood to repay the sum owed is another example of this. This may take form by offering a reduced loan to a student with no credit history, or offering a high value loan to a client with an excellent credit rating. Utilising this method will enable you to reduce your credit exposure risk by lowering individual credit risk of certain clients.
Purpose of Credit Insurance
Some risk is inevitable, that’s just the name of the game when it comes to business. Recent months have shown just how unpredictable the economy can be with many businesses falling victim to the devastating effects of the Coronavirus. It is more important than ever to ensure your business is protected against the unknown.
Studies have shown that the majority of business failures are not due to lack of sales or opportunity, rather due to poorly managed cash flows and increased credit risk. Many business owners have found themselves ignoring cash flow and credit risk in favour of focussing on revenue and sales. While this problem may directly affect your clients, it will indirectly affect your business if you do not have adequate measures in place to protect yourself from credit default.
Credit insurance is the best and safest way to ensure your business is protected against concentration risk and counterparty credit risk. Your business may also be exposed to commercial risks such as if your clients are unable to pay within the agreed time frame, or become insolvent. In these cases your insurance will cover things such as the standard services or goods that are sold.
Credit insurance plans are customisable and can be tailored to meet the specific needs of your business including risks such as binding contracts and works in progress. Credit insurance is vital for businesses of any size to help protect their cash flow and ensure the business is able to continue trading with no issues.
Get Serious About Protecting Your Business
Niche Trade Credit has over 30 years experience in credit management and credit insurance services. If you are serious about protecting and growing your business, contact us today on 02 9416 0670.
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