Business credit: Making informed credit decisions
Private companies pose unique challenges for banks and others trying to quantify the credit risk associated with those companies in an automated and standardized manner. Since privately held firms aren’t required to share financial information with outsiders, the number of parties with access to accurate, detailed information about the business is extremely limited. Financials for the business owner and for the company are often entangled. For example, owners often use personal credit for their companies. In addition, a firm with multiple business owners could have numerous financial commitments outside the business that may be difficult to ascertain.
Even with access to a private firm’s financial statements, it can be difficult to evaluate risk tied to a potential line of credit, supplier agreement or other partnership without knowing how the financials compare to peers.
Many lenders rely on the borrower’s personal credit score, along with a manual review of the business’s financial statements, to glean signals of the borrower’s financial health and creditworthiness. But it’s challenging to assemble information during the credit-risk management process in a way that provides a quality credit assessment. Furthermore, many community banks and other creditors cannot quickly nor economically access sufficient data to develop statistically valid, data-driven models that can predict the default risk of typically opaque and very heterogeneous loans.
In addition, not all firms have a credit rating that can be accessed through one of the traditional providers due to their start-up status, while some credit-scoring models may rely on outdated data. For example, consider how quickly the business environment changed between mid-2008 and late 2009; evaluating a company’s 2007 payment history would have been of limited use in evaluating a company’s credit risk in 2009.
How can a probability of default or a business credit score help when analyzing private companies?
• Help banks quantify and standardize their credit risk assessments.
• Enable companies to perform risk exposure due diligence on vendors.
• Assist private businesses as they evaluate their own creditworthiness.
To learn more about how to make the smartest credit decisions, check out this free whitepaper: Shifting Credit Concentrations: 6 Ways to Prepare