What is Credit Risk and How Does it Affect My Business?

Credit risk is the risk of loss due to a default on a contract, or more generally, the risk of loss due to some "credit event". Traditionally, this only applied to situations where debt holders or business owners were concerned that the debtor or customer to whom they made a loan or extended credit might default on a payment. For that reason, credit risk is sometimes also called default risk.

In business, almost all companies carry some credit risk, because most companies do not demand up front cash payments for all products delivered and services rendered. Instead, most companies deliver the product or service, and then bill the customer, often specifying their terms of payment. Credit risk is the time in between when the customer leaves with the product or service and when you get paid.

Managing this risk is important for any business but especially for new or small businesses. For larger companies, there may be a credit risk department whose job it is to assess the financial health of their customers and extend credit (or not) accordingly, much like a credit manager. For example, a new business that is selling its products to a troubled customer may attempt to lessen credit risk by tightening payment terms to "net 15" or by actually selling less product on credit to the retailer, or even cutting off credit entirely and demanding payment in advance. They might even lower the existing credit limit and re-run the credit application to re-evaluate the credit risk factors. This will probably cause friction in the relationship with the customer but you will end up better off if the customer is late paying their bills, or especially if they default and you have to place the account for collection, take them to court or if they file bankruptcy.

Credit risk is not really manageable for very small companies with only one or two customers. This makes these companies very vulnerable to defaults or even payment delays by their customers. Thus the reason to have a sound credit policy in place.

Some things you can do to limit your risk are:

* Get a personal guarantee
* Offer month-to-month credit
* Offer ship-to-ship credit
* Ask for a security deposit
* Get a 50% deposit on every order

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This is an excerpt from Michelle Dunn's e-book "Effective Collections, a proactive approach to credit management" Called the Nations authority on collecting money, Michelle Dunn is an award winning author and columnist. She is the founder and CEO of the American Credit & Collections Association, one of the Top 5 women in Collections, and one of the Top 50 most influential collection professionals in her industry. Michelle has been quoted and featured in The Wall Street Journal, Smart Money Magazine, CNN & other National publications.

Visit http://www.michelledunn.com and http://www.credit-and-collections.com for more information.