What is credit portfolio management?
Credit Portfolio Management (CPM) involves the analysis of a business or lender’s credit portfolio to determine an effective balance of net risk and growth. The larger the diversity of borrowers and loan amounts, the more critical this process is. At banks and large lending institutions, whole teams of credit professionals are devoted to taking a broad view of the overall lending position to determine if it is sustainable. They do so by analysing risk factors and KPIs including the probability of default (PoD), payment history and credit score.
With proactive credit portfolio management, using leading tools such as DebtorLogic and RiskScore from CreditorWatch, a creditor may reduce exposure to defaulting or insolvent borrowers.
What is a credit portfolio?
The term ‘credit portfolio’ encompasses the full breadth of a company’s lending position. This can include money lent, credit owed in accounts receivables by clients, and illiquid loans of assets such as cars or buildings. Your credit portfolio collects all of these debts owed into one place, allowing you to compare and contrast debtors, analyse risk and project future performance.
Some institutions, such as banks and insurance providers, intrinsically have more complex and diverse credit portfolios than other businesses. Loaned amounts may vary from small to very large, with considerable variations in repayment periods, interest settings and agreement terms. As a business’s credit portfolio becomes more complex, so too does the process for determining its overall risk exposure, which may result in the use of niche systems such as credit card portfolio management software. Additionally, the job description for many employees may centre around the determination of credit risk and revenue security.
As credit risk analysis technology has progressed, as demonstrated by the gold standard RiskScore and Credit Reporting tools from CreditorWatch, the importance of credit portfolio management metrics and analysis has grown. Quantitative credit portfolio management information has proven to be invaluable in helping businesses navigate the threat posed by risky entities. In particular, businesses with a wide array of creditors, especially in default-prone industries like construction, understand the importance of utilising data and sophisticated risk assessment to inform their decisions.
Why is credit portfolio management important?
Overexposure to risky debtors within a credit portfolio naturally increases a creditor’s chances of insolvency. The level of credit risk that a lender can accommodate varies according to factors such as their available liquid and non-liquid assets, overhead costs and investor confidence. Watertight portfolio management and credit and collections tactics are critical because they can allow such businesses to pre-emptively determine that their net risk position is too great. If so, they might be able to take action to reduce their overall risk exposure prior to disaster.
For example, a commercial lender may be able to absorb one or two defaulting borrowers over time – this is almost to be expected given the natural fluctuations of the business cycle. However, if too many of its borrowers default at once, the lender may suddenly no longer be able to pay necessary outgoings such as rent, wages and utilities. If they have no forewarning, the revenue collapse could be fatal. Active credit portfolio management, which involves taking steps to analyse the creditworthiness of debtors utilising information such as CreditorWatch’s extensive trade payment data, can mitigate this risk.
How does credit portfolio management work?
For most companies, the objective of credit portfolio management is to maintain a sustainable balance of risky vs safe debtors – and what that looks like can vary. If a company operates in an industry with higher instances of insolvency and external administrations, such as Food and Beverage Services, it may need to adopt more stringent risk management practices by default. What might be perceived by one business as an overly risky credit portfolio could be considered acceptable by another if they have greater levels of cash in the bank to cover negative outcomes.
Some companies may also take on a higher net risk position if they are seeking aggressive growth. Effective credit portfolio management meaning can vary according to what stage of life the lending business is in. It’s a similar proposition to trading in stocks – higher growth ambitions often accompany a wider range of acceptable risk factors. To effectively gauge its lending position, credit portfolio risk exposure, and ultimate credit management objectives, a company should always refer to professional financial advice that takes into account its individual circumstances and growth phase.
No matter the business, some of the fundamental tenets of credit portfolio management remain largely the same:
- The data has to be reliable. Credit portfolio management (CPM) level 1 requires relevant and clean data in order to be effective. Client details, the amounts lent, the terms and conditions – all pertinent information must be correct and accessible. Business owners can leverage tools such as the Portfolio Health Check from CreditorWatch to ensure that their customer or supplier data is accurate and standardised for easy readability. Capturing vital information from ASIC, AFSA and the ABR, the process is vital for any business looking to leverage well-informed analysis. Businesses must maintain these data accuracy standards when onboarding new customers as well. Onboarding all client businesses into trade payment platform DebtorLogic via ApplyEasy ensures this essential information is up-to-date – consequently allowing you to easily compare and contrast different debtors against industry averages.
- Credit reporting and credit scores are fundamental. Credit checking debtors, either existing or new, is integral to understanding risk exposure. Your business must be able to derive how likely that client is to pay, if there are any events to be aware of in their credit history, and how their creditworthiness and probability of default (PoD) compares to industry standards. Utilising the machine-learning technology of RiskScore, CreditorWatch clients can determine credit risk for partner businesses easily and intuitively. With an ABN search, client businesses can be scored from 0-850 and placed in a tier of credit risk from A1 to F. The higher the score, the lower their credit risk.
- High value clients deserve extra due diligence. If the value of credit loaned to a single entity is higher than normal, then extra checks and balances should be observed. Should a high-value debtor default – the damage to the creditor will likely be significant. A full Financial Health Check from CreditorWatch seeks to address this elevated risk with a comprehensive deep-dive of two to three years of a company’s financials, including cash flow, income statements and bank statements. This is then translated into succinct analysis from a qualified Chartered Accountant (CA) or Certified Professional Accountant (CPA), allowing your team to make the most informed decisions to reduce risk exposure.
How can I find out more about credit portfolio management?
For more information on how to proactively manage your credit portfolio of trading partners and suppliers, contact our expert CreditorWatch team today. Our sophisticated credit reporting suite leverages extensive information including trade payment data from over 55,000 customers to deliver accurate and intelligent insights. Our experience has allowed us to assist so many Australian businesses in understanding their risk exposure and empowering their team with the tools to take action.
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