How to Assess the Creditworthiness of a

New Customer
Key Takeaways

 Assessing the creditworthiness of a new customer is essential for maintaining a steady

cash flow and avoiding cash flow problems in your business.
 The five Cs of credit (character, capacity, capital, collateral, and conditions), help
evaluate a customer’s ability to repay borrowed credit.
 To minimize financial risk while extending credit, utilize digital credit management and
automated scoring.
 Optimizing working capital and minimizing risk can be achieved by implementing digital
credit management processes and utilizing automated credit scoring solutions.

Introduction
It is no secret that a steady cash flow is crucial for operating a successful business.
However, it may surprise you to learn that cash flow issues often play a significant role
in the downfall of many businesses, particularly SMBs.
According to a QuickBooks survey, 60% of small business owners have encountered
cash flow problems in the post-pandemic economy.

One of the major reasons for cash flow problems is late or non-payment. This occurs
when businesses extend credit to customers without conducting proper creditworthiness
evaluations.

To avoid cash-related challenges, small and mid-sized businesses should establish a

robust credit check policy before onboarding new customers.

What Is Creditworthiness?
Creditworthiness is an evaluation of a company’s financial reliability to
ensure that it can meet its debt obligations on time. This assessment
is crucial for businesses, as it helps them make informed decisions
about whether to offer credit terms to another company or not.

B2B creditworthiness hinges on various factors. First, a company’s

financial stability, reflected in its consistent revenue, plays a vital role.
Equally important is the payment history: on-time payments improve
creditworthiness, while late or missed payments have a negative
impact.
Another vital aspect is the business’s credit score, which is a
numerical representation of its creditworthiness. Lenders and
suppliers often rely on credit scores to quickly assess the risk
associated with extending credit to a customer.
What is corporate creditworthiness?

Corporate creditworthiness refers to the financial reliability of a

corporation, specifically focusing on its ability to fulfill financial
obligations.

Corporate creditworthiness is assessed through various metrics, one

of which is the business credit score. This score serves as a measure
of a company’s financial stability and its likelihood of fulfilling its
financial commitments promptly. Ranging from 1 to 100, with higher
scores indicating better creditworthiness.

What Are the 5 Factors of Creditworthiness?

Businesses use multiple criteria to evaluate creditworthiness of a customer.
The five Cs of credit is one of the most well-known techniques for
assessing creditworthiness. Understanding the five Cs—character,
capacity, capital, collateral, and conditions—can assist in determining a
customer’s capability to repay the borrowed credit. Let’s look at what each
one signifies.

1. Character

Character assesses how dependable and trustworthy a customer is. To gauge a

customer’s character, one must analyze their credibility and background. Credit history
is one of the main factors to consider while evaluating a customer’s character. It
contains a detailed description of the customer’s credit report and credit score. This
data includes how long the customer has been in business, bankruptcies, whether they
make timely payments, and more. Credit scores vary from 300 to 850, with higher
scores indicating strong creditworthiness of a company.

2. Capacity
Capacity refers to the ability of the customer to repay their debt. To evaluate the
capacity of a customer, consider cash flow statements, business debt, and payment
history. The Debt Service Coverage Ratio (DSCR) and Debt-to-Income ratio (DTI) help
evaluate a company’s cash flow and overall health. A DSCR of 1.25 or higher and a DTI
ratio of 36% or lower is considered ideal.

3. Capital

Capital signifies the total funds and assets (both financial and non-financial) owned by a
company. Before extending credit to a new customer, evaluate the worth of the
customer’s business in terms of their investment in fixed assets and other instruments.
Review the customer’s bank records and financial statements to get a clear picture of
their capital. If these statements show a trend of strong capital growth, the customer is
less risky and can be assigned a higher credit limit.

4. Collateral

Collateral refers to assets that a customer commits to back a line of credit. These may
include fixed assets such as inventories, corporate bonds, or real estate. Companies
often require collateral as assurance for extending credit. When dealing with a high-risk
customer, it’s advisable to ask for collateral to minimize the likelihood of bad debts.

5. Conditions

Conditions are terms established by a company based on its policies, economic

conditions, or prevailing regulations in the customer’s operational region. Geographic
location, industry type, currency fluctuations, and the political environment are factors
influencing a company’s payment terms and conditions. A customer situated in a stable
geopolitical environment is more creditworthy, facing lower economic risks

How To Determine Creditworthiness of a Customer?

Before granting credit, a company should assess the customer’s
competence to manage and repay outstanding debts. Here are six
ways to determine the creditworthiness of a potential customer.
1. Collect relevant details to extend credit

Collecting relevant information about the client is the first step in

assessing creditworthiness. Before extending credit, it's crucial to ask
customers to complete a business credit application form, which
includes general business information, bank references, credit history,
and more. These details help consolidate client data, expediting the
customer onboarding process.
2. Check credit reports

Analyzing credit reports is an ideal method to evaluate

creditworthiness of a customer. A credit report contains information on
the company and its financials, enabling you to generate credit scores.
It depicts a company’s capacity to pay by tracking its payment history
and public records. Credit reports of a company are available for
purchase from credit reporting agencies such as Experian, D&B, and
Equifax.
3. Assess financial reports

The financial report of a company provides insights into its cash

position. Financial reports include the cash flow statement, income
statement, and the balance sheet of the company. The financial health
of a new customer should be examined thoroughly by reviewing their
public financial statements.
4. Evaluate the debt-to-income ratio

Another way to evaluate the business credit risk of a customer is by

examining their debt-to-income ratio. This ratio provides insights into
how much of their monthly income is allocated towards debt
repayment. Calculate the ratio by dividing monthly debt payments by
gross monthly income.
A low DTI ratio indicates a healthy balance between debt and income, whereas a high
DTI ratio shows that a client has more obligations than the monthly income.

5. Conduct credit investigation

You must use multiple sources to conduct further investigations to evaluate the
business credit risk of a customer. These investigations should contain:

 Customer background and history

 credit policies
 Accounts receivable aging report
  Economic and political climate analysis
 Future business probability
All these factors contribute to better decision-making and customer authentication.

6. Perform credit analysis

After gathering all necessary information about the new customer, conduct a
comprehensive account analysis. Evaluate trade references, scrutinize financial
statements, and apply credit analysis to predict the probability of default. While
performing credit analysis, the profitability ratio, leverage ratio, and liquidity ratio are
some of the key financial metrics to consider.

How to Evaluate Credit Worthiness When There Is No Data

Available on the Potential Customer?
While onboarding new customers, a company runs credit checks through credit
reporting agencies. However, sometimes credit agencies may not have all the required
information or may have incorrect data. Such a situation does not indicate that the client
is not creditworthy. It simply implies that the company did not supply sufficient
information to the agencies to generate a credit report.

Asking the client to provide active trade references can solve the issue. A trade
reference is a detailed report of the customer’s payment history with its vendors and
suppliers. It provides much information on the client’s credibility. Checking further with
these vendors and suppliers can help you get more details on the customer. Here are a
few questions you can consider asking:
Going above and Beyond
Mid-size businesses often rely on their customers for their working
capital requirements and hence need to keep a close eye on the
clients’ financial health. Use the tips provided in this step-by-step
guide to optimize your working capital and minimize risk.

To streamline your credit portfolio and customer onboarding, replace

paper-intensive credit management processes with digital practices.
Utilizing solutions like RadiusOne Credit Risk Application will help you
become more efficient. Our automated credit scoring feature, based
on industry-specific best practices, helps you predict customer
payments.
 Understanding Trade Credit
Insurance: meaning, key benefits
and examples
Trade credit insurance is an important tool for businesses looking to protect
themselves against trade credit risk. This type of insurance can help to mitigate the
potential impacts of bad debt and insolvency, allowing businesses to expand and
grow with confidence.

In this article, we will explore the meaning of trade credit, how credit
insurance works, the benefits of trade credit insurance, and real-life examples of its
application.

Trade Credit: advantages and disadvantages

What is the meaning of trade credit?
Trade credit refers to the practice of extending credit to another business, allowing to
purchase goods or services without having to pay for them immediately.

What are the benefits and drawbacks of

providing trade credit?
The importance of trade credit for businesses transactions lies in the fact that it allows
companies to purchase the good or the services they need to operate without having to
pay for them upfront.

Providing payment terms to customers can bring to:

 Increased sales: by offering credit terms, it becomes easier and more convenient for
customers to purchase goods or services

 Customer loyalty: when customers are given the option to pay for good or services
with credit terms, they may be more likely to return in the future
 Enhanced understanding of customer creditworthiness: by extending trade credit to
customer, a business can gain a deeper understanding of the creditworthiness of
potential customers, if supported by the right tools and procedures

 Competitive advantage: Offering payment terms can also give a business a

competitive advantage over other businesses that do not offer credit, making them
more attractive to customers.

Providing payment terms to customers is essential to many business transactions,

but it also comes with risks: if a customer defaults on their payments, it can result in
substantial financial losses.

A strong credit control procedure is essential for every company, whether large or small,
and outsourcing this activity can be the most effective alternative: for example, a
good trade credit insurance policy, enables companies to control their financial
situation and the long-term management of their client portfolio.

Understanding how Credit Insurance works

What is a credit insurance policy?
Trade Credit Insurance is an insurance service that protects transactions between
companies, which supply goods or services with deferred payments: it covers the risk
of non-payment when a business offers a trade credit to a corporate customers.

Which type of risk is covered in credit insurance and

how does it work?
Trade credit insurance covers business-to-business accounts receivables from
commercial risks.

The credit insurance provider monitors creditworthiness and financial stability of

the policyholder's customers and assign them a credit limit, which corresponds to
the amount that will be indemnified in case of non-payment.

The Credit Insurer proactively monitors customers’ buyers throughout the duration of
the policy, by gathering information and matching them with economic intelligence,
market trends and industry risk analysis. Throughout the life of the policy, the
policyholder may request additional coverage on a specific buyer should that need
arise.

The ultimate goal of a trade credit insurance policy is not to simply pay claims as they
arise,
 but more importantly to help policyholders avoid foreseeable losses. Credit
insurance goes beyond indemnification and does not replace a company’s credit
practices, but rather supplements and enhances the job of a credit professional.

If an unforeseeable loss should occur, the indemnification aspect of the trade credit
insurance policy comes into play. In these cases, policyholders would file a claim with
supporting documentation, and the insurer would pay the policyholder the claim benefit.

The benefits of trade credit insurance

Companies invest in Trade Credit Insurance for a variety of reasons, including sales
expansion, better financing terms, reduction in bad-debt reserves and – most of all
– protection against non-payments and unexpected losses.

All the benefits of providing trade credit to customers, such as increased sales,
improved customer loyalty, and enhanced understanding of customer creditworthiness,
can be further amplified by implementing a credit insurance policy. By ensuring against
the risk of non-payment, a company can expand their business, attract new
customers, and retain existing ones, while also trading with a greater sense of security
and peace of mind.

Real life examples of trade credit insurance

Real-life examples of trade credit insurance in action can be found in many different
industries, countries and business environments.

Here are a few examples of how trade credit insurance might be used by different types
of companies:

1. A manufacturer that sells goods to retailers

2. A wholesaler that sells goods to distributors

3. An exporter that sells goods to international buyers

In conclusion, by understanding the meaning of trade credit, how credit

insurance works, and the benefits it can provide, companies can make informed
decisions about how to mitigate the risks they face and expand their business with
confidence.
What Is a Credit Application?
DEFINITION

A credit application is a form a borrower fills out to request credit. The form can usually be submitted
either online or in person.

Key Takeaways

 A credit application is a request for a loan or line of credit.

 The information included in a credit report helps the lender determine whether the borrower is
a good candidate for a loan.

 You can usually fill out a credit application either online or in person.

 Lenders are required to notify you in writing and provide a reason if they deny your credit
application.

 Revolving credit and installment credit are two primary forms of credit that borrowers can apply
for.

Definition and Examples of a Credit Application

A credit application is filled out by a borrower and submitted to a lender to request a loan or other
financing. A contractual relationship begins between the borrower and that lender when the lender
receives a credit application.

The application provides the lender with important information about the borrower. Applicants will
typically be asked to include the following information on a credit application:1

Address

Phone number

Social Security number

Employer identification number (EIN) for business loans

Credit references

The information provided on the credit application will make it easy for the lender to send the customer
to collections or pursue legal action if the loan is granted and the borrower defaults on payment.
How a Credit Application Works
You’ll start the process of applying for credit or a loan by filling out the credit application and providing
all the necessary information. Your lender will then most likely pull your credit report, and it will look at
factors like your income and debt-to-income ratio, as well.

The exact underwriting requirements will depend on your lender. Underwriting is the process by which
the lender determines whether it wants to extend credit. Your lender will use the information provided
in the credit application to determine whether you’re a good candidate for a loan.

Filling out a credit application is easier than ever thanks to an abundance of online lenders. Technology
often makes it possible for borrowers to fill out the application entirely online, and they can find out
whether they’re approved within minutes.

If you're denied a loan, the lender must send you a letter explaining the reason why. All lenders are
required to either provide a specific reason for the rejection or let you know that you have the right to
request this information within 60 days.2

The lender must inform you, as well, if it rejects your application due to the information contained in
your credit report. It must give you the name, address, and phone number of the credit reporting
agency that supplied the report.

Types of Credit

Most borrowers apply for two primary types of credit. Each can be a good option depending on your
needs and your financial situation.

Revolving Credit

Revolving credit is an ongoing type of account, like a credit card or a line of credit. You'll receive a lump
sum of money when you take out a loan, and you'll make payments until the balance is reduced to zero.
You can repeatedly use and pay down the credit line over time with a revolving line of credit.

Your lender will set a credit limit when you're approved for a credit card. This is the maximum amount
of money you can charge to the card. Your credit card will remain in good standing as long as you stay
below the limit and continue making payments.

Installment Credit

Installment credit is a close-ended credit account that you repay in monthly installments. You’ll either
receive the money upfront or the funds will be applied toward an item you’re purchasing. The account is
closed when you’ve finished repaying the installment loan.

Mortgages, car loans, student loans, and personal loans are all popular types of installment loans. They
appeal to many borrowers because of the predictable payment terms and the option to refinance.

Try to improve your credit score as much as possible if you’re considering applying for an installment
loan. A good credit score will help you earn the best rates and repayment terms on the loan.