Keys to Conducting a Comprehensive AR Risk Assessment

Whenever there’s new uncertainty, it’s crucial that the AR credit team conduct a comprehensive risk assessment – a deep-dive analysis of how your customers, and their supply chain, are affected by the new form of vulnerability.

 Systemic Risk

Begin by understanding how your customers are affected by changes in the economy or industry. The threat of an increase in international tariffs, for example, could raise prices for imported products, upsetting the assumptions you had about the client’s financial position.

It’s also important to think about vital parts of your customers’ supply chain – i.e., who they buy component parts from, and who their suppliers buy from – to see how you could be indirectly affected. This is especially vital if there’s a limited number of suppliers in their supply chain.

 Non-Systemic Risk

This can also be a great time to re-evaluate your top customers’ financial well-being, including their:

• Enterprise Strength: The overall health of the business, including its ability to pay debts and generate profits.
• Accounts Receivable Status: The quality and reliability of their accounts receivable.
• Supply Chain Operation: The performance of all businesses in the supply chain.
• Insurance Company Performance: The ability of the insurance company to pay claims.

Also, ask about your customers’ AR. Just like your own team, the longer revenue goes uncollected the less likely it is to be collected in full.

If you’re working with smaller, new or high-risk businesses, it’s important to make sure their costs are covered. Ask if banks have required they take out credit insurance to provide assurance to the lending institution. This could be a sign of insufficient credit capacity.

This is a yellow flag – not necessarily a red flag. Credit insurance can lower the interest rates on loans by improving the business’s creditworthiness. Credit insurance helps banks by sharing the risk and ensuring loan repayment.

 Credit Risk Models

Once you’ve collected as much data as you can, think about how you want to structure that data to evaluate credit risk. Consider factors, such as: business environment, supply chain relationships, and the strength of the financing and core enterprises.

Identify a numerical weight to each risk factor to establish a ranking system. This should help make sure the assessment model is consistent and reliable.

IOFM has created an internal assessment checklist that can be assessed here. (It’s designed for Accounts Payable teams, but can easily be adapted for AR.)

 Ongoing Monitoring

You don’t have to wait for a global crisis to evaluate your customers’ credit worthiness. Continuously monitor the qualifications of your clients to effectively manage risks effectively.

A common best practice taught in IOFM’s AR Manager Certification course is to re-evaluate existing customers on the anniversary of when they were entered into the Customer Master File. That way, the work is spread out over the year – but not skipped over.