Corporate Credit Risk
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"Customer Risk" may be defined as the risk that a buyer will fail to pay either due to financial constraints (bankruptcy) or due to dishonesty (indefinite payment delays without good reason).

This is the main element of risk which is under the direct and active control of the management of the buyer. The buyer’s management must be honest. The buyer’s management must also be capable of operating the business effectively day to day and of dealing with any crisis effectively.

Hence a perceptive assessment of the ability of the management of a customer / buyer is as important as a competent assessment of the financial and commercial information presented for analysis.



Customer Risk Analysis is the subject of numerous academic studies, text books and courses. It is not possible to summarise this still expanding body of knowledge in this publication. The interested reader is encouraged to study this subject in more depth through reading appropriate texts, attending courses and membership of a relevant professional group.

The most important tools used by credit analysts are:

  1. Financial information as to the condition and achievements of the buyer; usually financial statements produced by the buyer in the form of a Balance Sheet, an Income Statement (or Profit and Loss Account), a Cash Flow Statement and explanatory notes.

  3. Information as to the future plans and strategies of the buyer as evidenced by executive announcements (accompanying the financial statements), literature distributed to shareholders and the public at large and Cash Flow Forecasts.


  5. Performance information gleaned from other suppliers (credit references), banks (bank references), the seller’s own records, credit reference agencies and public records such as court files and newspaper advertisements.


  7. Generally available information regarding the buyer’s industry and market environment together-with information regarding the legal and tax environment in which the buyer operates.


  9. Personal visits to the buyer’s premises and market. (See Customer Visits Strategy)



Financial information supplied by the buyer must be considered with extreme care even if it is accompanied by a "clean" auditor’s report.

The first important point to bear in mind is that any such information is a record of the past which does not necessarily indicate what the buyer’s position may be in the present or future.

The Balance Sheet is particularly "static" and vulnerable to manipulation. It is "static" in that it represents the asset and liability position at the close of business on a particular day. The picture before and after that instant in time will be different. It can be manipulated because generally accepted accounting practices give a great deal of flexibility to management and auditors, to determine how various transactions, assets and liabilities should be represented in financial statements. Hence it is vital to read and analyse in depth all the notes that accompany financial statements.

Income statements suffer from the drawback of being vulnerable to manipulation through the flexibility allowed by generally accepted accounting practices. In particular the use of the accrual method (which entails profit and loss adjustments not related to cash flow) can give a distorted picture of the buyer’s achievements, and can lead to cash being paid out to shareholders (in the form of dividends) and to tax authorities at a time of cash shortage.

Most credit analysts utilise well known financial-statement-based-ratios to determine their credit decisions. This approach is well understood throughout commerce and industry so unscrupulous executives are able to manipulate credit analysts’ decisions by manipulating balance sheet and income statement figures to produce "desired" ratios.

Customer Risk relates specifically (i) to the availability of cash to meet payable commitments on due date and (ii) to the willingness of the buyer’s management to pay.

The Cashflow Statement is the most reliable of those documents which usually form the buyer’s set of financial statements. It reflects actual cash movements during the review period so it will indicate;

the buyer’s ability to generate cash,
the buyer’s strategy for the utilisation of cash generated,
sources of cash utilised during the year,
the cashflow cycle of the buyer’s business and
the buyer’s "defensive interval " .

A customer’s "defensive interval" is the time during which the customer can continue to operate its business utilising only cash resources (liquid assets) actually on hand on the relevant Balance Sheet date.

NOTE: Refer to various publications and presentations by Dr George GALLINGER (Arizona State University) for more information about ‘cashflow analysis’, the ‘cashflow cycle’ and the ‘defensive interval’. Fax: (602) 965 8539. Email: 



It is true that the future is less and less likely to resemble the past, given the rapid pace of change being experienced. The challenge is to predict the probability that the buyer’s management will be able to successfully cope with the future.

In order to make an assessment, the credit analyst needs to;

assess the buyer’s business environment and its competitors’ possible strategies,
understand the buyer’s strategies and
reach a reasoned decision as to the probable efficacy or otherwise of the buyer’s plans.

The past (the buyer’s "track record") will be an important resource for the credit analyst as it may provide clues to the buyer’s abilities to deal with the future.


Important limitations are imposed on this technique by the following factors, when it is used in the corporate environment:

The number of customers with sufficiently similar characteristics to be grouped together for analytical purposes is usually too small to provide statistically reliable indicators.
Customers are able to manipulate the financial data which is used as the foundation of most credit scoring models.
The past is not a reliable indicator of the future in this environment.
All models contain several significant elements which are based on the subjective decisions of the human model builders.
Models do not ‘transfer’ successfully from one country to another.

Credit Scoring models are however able to provide a logical framework upon which to work step-by-step through the analysis of a customer’s position, before making a credit decision.

In order to develop a useful model a credit analyst would have to take into account the requirements and peculiarities of the selling company and its potential market. In addition any model should be tested as extensively as possible before it is utilised. The subjective elements should be reviewed regularly.

Refer to the Trade Credit ScoreCard Article and PowerPoint Presentation.


The company should create a method of calculating appropriate credit limits based on the following criteria:

  1. Each unsecured limit should not exceed the maximum amount the company could bear to lose without becoming bankrupt. A useful guideline to this amount may be a proportion of the company’s "own funds" (shareholders’ equity), say 10% for example.
  2. Each limit amount should not exceed the customer’s assessed ability to pay, in the normal course of business. Attention should be given to the normal pattern of a customer’s business; normal purchase levels, sales levels, usual credit terms prevalent in the customer’s market, the relative size of the customer’s business and its relative financial strength.
  3. The limit amount should be sufficient to accommodate the customer’s normal purchasing pattern. If it is not possible to meet this requirement the company should explore the possibility of sharing the payment risk, with a bank or credit insurance entity, transaction by transaction.

© Copyright 1998  R K WELLS

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Last Updated:  February 01, 2020 18:25 -0000