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“In today's commercial realities, effective risk management in companies is imperative to their long-term sustainability and growth.”

Effective credit risk management: vital for business survival

Banks have been doing it for decades. They deploy powerful credit risk assessment and management tools to make sound decisions when lending to businesses. This is accepted and routine good practice in the major banks.

But the same can't be said for the majority of organisations in other industries. A sample analysis was done of company bad debts
from 2008 to 2011. The percentage of increase in their bad debt was startling:

Company	Increase in bad debt as a % of revenue
Murray & Roberts	234%
Bidvest	500%
Mustek	263%
Sasol	341%
Tiger Brands	300%
Nampak	152%

Note: This analysis is based on information disclosed on bad debts and impairments in the financial statements of the sampled companies. As the definitions of impairments are not identical, caution should be used in comparing the rate of bad debts between companies (for example, it is not always clear whether the disclosed expense is net of any risk mitigation from insurance). The above table does however provide a strong indication that between 2008 and 2011, bad debts relative to revenue grew significantly within this sample.

Until recent years, businesses generally faced a level of credit risk that could be reasonably addressed and managed using a combination of standard due diligence procedures, a bit of research, and a healthy measure of common sense. Massive shifts in the global business environment over the past decade have however meant that this relatively superficial level of credit risk management simply doesn't pass muster anymore. These shifts have caused tangible changes, like the dramatic increase in leverage as reflected in the balance sheets of companies. Although some deleveraging has since occurred, companies in general remain more leveraged than 10 years ago. As a consequence the overall approach to debt is considerably more aggressive than before. As economies globalise, companies are doing business with more other businesses than ever before. It's becoming easier to make contact with end users, meaning that intermediaries and counterparties are becoming less prevalent.

Modern businesses serious about their long-term success - and even their survival - need to take a far more thorough approach to credit risk management than in the past. This paradigm shift has been necessitated by a combination of factors, the most obvious being the altered economic backdrop against which all businesses now operate.

The credit crunch of 2008 and its resulting and ongoing impacts focused a harsh spotlight onto credit management within the financial industry. More than that, it brought with it a stark reminder of the fragility of business, as companies must recognise that counterparty risk can no longer be brushed over. The dramatic collapse of Lehman Brothers placed some of the world's largest banks and insurance companies at risk of failure. If these giant institutions could collapse, surely any business can - and if that business is connected to yours, its collapse could well lead to the downfall of your operation.

The financial officers in companies are facing increasingly stringent legislation and heightened requirements for good governance, risk management and accountability. In the relatively short period of a decade, credit risk has gone from being a necessary business evil to a strategic survival imperative.

Of course, businesses are also realising that risk is not just something that needs to be contained. Identified correctly and leveraged appropriately, risk – of various types – can be transformed into significant strategic opportunities or competitive advantages.

But regardless of the reasons for introducing risk management, the first step for businesses is to accurately identify and quantify such risk. When companies have a grasp of their credit risks, they should manage these as an integral part of the business. The business world would do well to take a leaf from the South African banking industry's book on risk management.

For many years now, South Africa's leading banks have based their commercial and corporate lending decisions on rigorous and highly effective credit risk identification and assessment. Coupled with the fact that these banks were early adopters of Basel II, risk management was arguably a primary reason why South Africa's banks were significantly less affected by the global financial crisis than their international counterparts.

That banks used effective credit risk analysis to buffer themselves against international economic meltdowns is a compelling reason for broader business to take a similar approach. This is especially true in an era where partnerships, associations, and mergers are increasingly the order of the day. While these types of relationships undoubtedly present many opportunities for growth, they also raise the issue of counterparty risk that can make or break businesses.

The Credit Factory have witnessed at first hand the steady rise in the need to manage credit risk within the business environment. They responded by developing a set of credit risk management tools that make the proven risk management techniques of the financial services industry available to general businesses.

The portfolio of risk solutions is a first in South Africa and allows for effective counterparty risk assessment, company risk grading, and accurate portfolio analysis.

Used in conjunction with standard due diligence procedures and credit bureau reports, these will provide the data that companies need to better protect themselves from credit risk, while also providing a solid platform from which to make well informed risk-based decisions.

In today's commercial realities, effective risk management in companies is imperative to their long-term sustainability and growth. asa

Author: Laurence Milner CA(SA) is the CEO of The Credit Factory.