3 factors that impact credit risk

Credit risk is the risk associated with granting credit to another party. For example, if you sell an item on credit by offering an invoice or part payment, or lend money. An increase in credit risk can affect your business in several ways:  

• Time taken to pay: customers take longer to pay, forcing you to bridge the gap between sales and payment.
• The risk of the money not being paid at all increases.  
• Changes in credit risk can lead to greater write-off levels, despite continued growth in the economy.

Many companies are not aware that credit risk can increase, even when the economy is growing

Fortunately, there are several macroeconomic variables that give clues as to how the credit risk will develop for your business.

Risk assessment - debt collection

Debt collection among companies shows the default level generally and gives an indication of how robust the companies' finances are. This is useful information for risk assessment in your business.

To calculate the default, we look at total debt collection among limited companies, the proportion of limited companies with debt collection and the average amount in debt collection per company.

If this rises proportionally, then the risk concentration increases. 

Transaction volume in the economy

The most important driver behind debt collection growth in the short term is the number of transactions in the economy. Increased demand from households generates increased demand between companies. This in turn will lead to an increase in the number of transactions.

If the proportion of companies that default is unchanged, the amount in default will increase as financial transactions increase. The credit risk, i.e. the probability of default, remains unchanged.

However, when the growth in transactions between companies flattens out, it can affect access to money, and thus the liquidity of individual companies. This can lead to it taking longer to resolve debt collection cases and so credit risk increases.

Household demand

The profitability of companies depends on household demand, i.e. consumers. And that demand is largely dependent on their disposable income - the income left over when consumers have covered their fixed costs.

Several factors affect disposable income, including:

• Borrowing rates: When interest rates rise, disposable income will decrease. Which in turn can affect both house prices and demand for other goods.   
• Wages: When real wage stagnation is combined with higher borrowing rates, it will lead to a reduction in disposable income.
• Debt level: High levels of debt increase vulnerability to rising borrowing rates. Looking at debt-to-income ratio is therefore important to calculate credit risk and evaluate who to grant credit.

Do you know how to segment your customer base to understand which clients to grant credit or not? We can help.

At Intrum, we know how to help our clients get paid on time. Our geographical reach and experience, combined with a range of services at all stages of the credit lifecycle put us in an ideal position to help you improve your credit management, while protecting the reputation of your business.

Our excellent customer care means you can relax, knowing we’re looking after your cashflow and your customers. For more information on how we can help…