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Risk Mitigation – The 5Cs
Risk mitigation reduces your risk when extending credit terms to commercial customers to increase sales. The 5Cs of basic commercial risk mitigation prevent future bad debt and mitigate financial disasters. Save yourself money and a lot of grief with our 5Cs of commercial risk mitigation.
If you are thinking about allowing commercial customers to open a credit account, or if you already have trade receivables, we recommend reviewing the following 5Cs of commercial risk mitigation:
Capacity Risk
Capacity risk or the ability to repay is the most critical of the 5Cs of commercial risk mitigation.
Capacity is the primary source of repayment - cash. You should know exactly how your customers repay their suppliers. You should consider the cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan. Payment history on their existing credit relationships (personal or commercial) are an indicator of future payment performance or risk.
Capital Risk
Capital is the money your customer personally has invested in their business. It is also an indication of how much is at risk should their business fail. Risk is less with a business owner who has contributed to the business from their assets and undertaken personal financial risk to establish the business. This factor should be factored into your strategy for risk mitigation.
Collateral Risk
Collateral, or guarantees, are additional forms of security you can obtain from your customer to mitigate risk. Receiving collateral means the customer pledges an asset they own, such as their home or equipment, to you with the agreement that the collateral will be the repayment source in case they can't repay the debt. A personal or corporate guarantee, on the other hand, is just that - someone else signs a guarantee document promising to repay the loan if the original customer can't. Either method is a good form of risk mitigation.
Risk Mitigation and Conditions
Conditions describe the intended purpose of the credit your customer is seeking from you. Will your goods or services be used for additional equipment or inventory? You should also consider local economic conditions and the overall climate within your customers industry and in other industries that could be a risk to their business. The economic environment a customer operates in should be factored into risk mitigation.
Risk Mitigation and Character
Character is the general impression you have of your customer. Risk mitigation here is an objective opinion as to whether or not your customer is sufficiently trustworthy to repay your receivable. A customer’s educational background and experience in business in their industry should be considered when assessing risk mitigation. The quality of their credit references and the background and experience levels of their employees should also be reviewed as part of risk mitigation.
These are just 5 basic points for Risk mitigation. If you have any questions about risk mitigation an AAB professional would be please to assist you. You ca also schedule a free consultation on Risk Mitigation.
