In business, there is a theory called risk creep. It states that if an organization is not actively seeking out potential sources of risk, then its overall risk is increasing. If you are not actively managing customer credit risk, then your overall portfolio credit risk is increasing.
Some readers might ask what I mean by “actively managing credit risk.” Some people might point to the fact their DSO is low as proof that they proactively manage risk. Others might point to procedures in place to ensure that all new applicants are evaluated before open account terms are offered… and they would be wrong.
“Actively seeking our potential sources of risks” suggests a proactive approach to credit risk management. Calling delinquent customers for payment is reactive. Evaluating new accounts in response to a credit application received is also reactive, not proactive.
These three steps can reduce credit risk creep:
- Score new customers from low risk to high risk, and please make sure the ratings are objective
- Update rankings periodically based on changes in the risk characteristics of individual customers, and
- Develop processes to address credit risk [and credit risk creep] at the account level as risk increase or decrease over time.
Managing risk requires action. It may be hard to know what action to take to manage credit risk creep, but taking action is the only way to more effectively manage this creepy issue.
By: Michael C. Dennis. Michael is the co-author of the Encyclopedia of Credit. Please visit www.encyclopediaofcredit.com