Finance AI Skill

Credit Risk Assessment

Evaluate and monitor the credit risk of customers, suppliers, and counterparties to minimize bad debt and payment defaults. Use when setting customer credit limits, performing credit checks on new customers, monitoring existing customer payment behavior, cl...

Credit Risk Assessment

Evaluate the creditworthiness of customers and counterparties, set appropriate credit limits, monitor ongoing risk, and minimize bad debt through structured credit management.

Workflow

Gather customer financial data: Collect financial statements, bank references, trade references, payment history, public credit bureau data, and industry information.
Run credit bureau checks: Pull credit reports from major bureaus (Dun & Bradstreet, Experian, Equifax) for business credit scores and payment behavior indicators.
Calculate internal credit score: Apply a weighted scoring model to assign a quantitative credit score and risk rating to each customer.
Determine credit limit: Set credit limits based on credit score, order history, collateral availability, and risk appetite.
Define payment terms: Assign payment terms (Net 15/30/45/60, COD, LC) commensurate with credit risk level.
Monitor ongoing behavior: Track payment patterns, flag early warning signals (late payments, reduced orders, negative news), and update risk ratings.
Calculate expected credit losses (ECL): Under IFRS 9 / ASC 326 (CECL), estimate lifetime expected losses and provision accordingly.
Review and adjust limits periodically: Quarterly review of high-risk accounts; annual review of all accounts.
Escalate deteriorating accounts: When a customer shows signs of financial distress, trigger collection escalation or credit hold.
Document and audit: Maintain complete credit files for audit trail and regulatory compliance.

Credit Scoring Model

INTERNAL CREDIT SCORING MODEL (100-Point Scale):

DIMENSION 1: FINANCIAL STRENGTH (35 points max)
  ──────────────────────────────────────────────
  Metric                      Score Range     Scoring
  ──────────────────────────────────────────────────────
  Annual Revenue              0–10 pts        >$100M=10 | $50-100M=8 | $10-50M=6 | $1-10M=3 | <$1M=1
  Profitability (Net Margin)  0–10 pts        >15%=10 | 10-15%=8 | 5-10%=6 | 0-5%=3 | negative=0
  Current Ratio               0–8 pts         >2.0=8 | 1.5-2.0=6 | 1.0-1.5=4 | 0.5-1.0=2 | <0.5=0
  Debt-to-Equity              0–7 pts         <0.5=7 | 0.5-1.0=5 | 1.0-2.0=3 | 2.0-3.0=1 | >3.0=0

DIMENSION 2: PAYMENT HISTORY (30 points max)
  ──────────────────────────────────────────────
  Metric                      Score Range     Scoring
  ──────────────────────────────────────────────────────
  Average Payment Days        0–10 pts        <terms=10 | 1-5 days late=7 | 6-15 late=4 | 16-30=2 | >30=0
  % Paid on Time (12-month)   0–10 pts        >95%=10 | 90-95%=8 | 80-90%=5 | 70-80%=2 | <70%=0
  Historical Defaults         0–10 pts        0 defaults=10 | 1 minor=5 | 1 major=0 | any bankruptcy=0

DIMENSION 3: EXTERNAL CREDIT DATA (20 points max)
  ──────────────────────────────────────────────
  Metric                      Score Range     Scoring
  ──────────────────────────────────────────────────────
  D&B Paydex Score            0–10 pts        >80=10 | 75-80=8 | 70-75=5 | 65-70=3 | <65=0
  Credit Bureau Rating        0–10 pts        AAA-A=10 | BBB=8 | BB=5 | B=3 | CCC and below=0

DIMENSION 4: RELATIONSHIP & OPERATIONAL (15 points max)
  ──────────────────────────────────────────────
  Metric                      Score Range     Scoring
  ──────────────────────────────────────────────────────
  Relationship Duration       0–5 pts         >5 years=5 | 3-5=4 | 1-3=3 | 6-12mo=2 | <6mo=1
  Order Consistency           0–5 pts         Stable/growing=5 | Variable=3 | Declining=1
  Collateral/Guarantee        0–5 pts         Parent guarantee=5 | LC=3 | None=0

TOTAL SCORE CALCULATION:
  Composite Score = Σ(dimension scores)
  
  RISK RATING ASSIGNMENT:
    85–100: Grade A (Low Risk)     → High limits, standard terms
    70–84:  Grade B (Moderate Risk) → Standard limits, standard terms
    55–69:  Grade C (Elevated Risk) → Reduced limits, tighter terms
    40–54:  Grade D (High Risk)     → Minimal limits, prepay or LC
    <40:    Grade E (Critical)      → No credit, COD only or decline

Credit Limit Setting

CREDIT LIMIT FRAMEWORK:

BASE CALCULATION:
  Starting Point = Average Monthly Purchases × Risk Multiplier
  
  RISK MULTIPLIER BY GRADE:
    Grade A: 3.0× monthly purchases (comfortable cushion)
    Grade B: 2.0× monthly purchases
    Grade C: 1.5× monthly purchases
    Grade D: 1.0× monthly purchases (capped at current run rate)
    Grade E: $0 (no credit extension)

ADJUSTMENTS:
  + Financial statements available and verified: +20%
  + Parent company guarantee: +30%
  + Letter of credit on file: +50%
  + Industry in growth phase: +10%
  − Recent late payment (>30 days): −30%
  − Industry in downturn: −20%
  − Geographic risk (high-risk country): −25%
  − New customer (<6 months): −20%

APPROVAL AUTHORITY:
  Limit Amount        Approver
  ─────────────────────────────────
  ≤ $50,000           Credit Analyst
  $50,001 – $250,000  Credit Manager
  $250,001 – $1,000,000  Credit Director + CFO sign-off
  > $1,000,000        CFO + CEO sign-off

INITIAL CUSTOMER CREDIT:
  • First order: Require prepayment or limited credit ($5,000–$25,000 based on grade)
  • After 3 on-time payments: Reassess for limit increase
  • After 12 months: Full credit review with financial statements

Early Warning Signal Matrix

MONITOR THESE SIGNALS — ESCALATE WHEN TRIGGERED:

GREEN (Normal — no action):
  ✓ Payments within terms
  ✓ Order volume stable or growing
  ✓ Positive financial news
  ✓ Credit score unchanged or improving

YELLOW (Caution — increase monitoring):
  ⚠ First late payment (1–15 days)
  ⚠ Order volume declining (>20% month-over-month)
  ⚠ Negative news (lawsuit, management change, layoff)
  ⚠ Credit score drops one grade
  ⚠ Customer requests terms extension
  ⚠ Payment method changes (e.g., from wire to check — may indicate cash stress)

  Actions:
    • Increase monitoring frequency (monthly → weekly)
    • Reach out to customer contact — "check-in" call
    • Review open invoices and upcoming orders
    • Prepare credit hold if no improvement in 30 days

RED (High Risk — immediate action):
  🚨 Payment >30 days late
  🚨 Customer bankruptcy filing or creditor notice received
  🚨 Credit score drops two or more grades
  🚨 Negative credit bureau alert (liens, judgments)
  🚨 Customer ceases communication
  🚨 Industry-wide crisis affecting customer

  Actions:
    • Immediate credit hold — stop all new shipments
    • Contact customer — demand payment plan for outstanding balance
    • Engage collections team or agency
    • Assess expected credit loss for provisioning
    • Legal team on standby if needed
    • Notify sales team — manage customer relationship carefully

Expected Credit Loss (ECL) Calculation

IFRS 9 / ASC 326 (CECL) — ECL CALCULATION:

ECL = Probability of Default (PD) × Loss Given Default (LGD) × Exposure at Default (EAD)

STEP 1: SEGMENT CUSTOMERS
  Group customers by credit grade or risk profile:
    Grade A: 60% of portfolio, average balance $500K
    Grade B: 25% of portfolio, average balance $300K
    Grade C: 10% of portfolio, average balance $200K
    Grade D/E: 5% of portfolio, average balance $100K

STEP 2: ASSIGN PD BY SEGMENT
  Based on historical default rates adjusted for forward-looking factors:
    Grade A: PD = 0.5%
    Grade B: PD = 2.0%
    Grade C: PD = 8.0%
    Grade D/E: PD = 35.0%

STEP 3: ASSIGN LGD BY SEGMENT
  Based on historical recovery rates:
    Grade A: LGD = 30% (70% recovery expected)
    Grade B: LGD = 50% (50% recovery expected)
    Grade C: LGD = 70% (30% recovery expected)
    Grade D/E: LGD = 90% (10% recovery expected)

STEP 4: CALCULATE ECL BY SEGMENT
    Grade A: 0.5% × 30% × $500K = $750
    Grade B: 2.0% × 50% × $300K = $3,000
    Grade C: 8.0% × 70% × $200K = $11,200
    Grade D/E: 35.0% × 90% × $100K = $31,500

TOTAL ECL = $46,450

STEP 5: FORWARD-LOOKING ADJUSTMENT
  Adjust PD for macroeconomic factors:
    • GDP growth forecast: If declining, increase PD by 20–50%
    • Industry conditions: If sector in distress, increase PD proportionally
    • Interest rate environment: Higher rates → higher PD for leveraged customers
    
  Adjusted Total ECL: $58,000 (25% upward adjustment for economic outlook)

STEP 6: RECORD PROVISION
  Journal Entry:
    Dr. Bad Debt Expense      $58,000
    Cr. Allowance for Doubtful Accounts  $58,000

Credit Policy Framework

CREDIT POLICY — KEY ELEMENTS:

1. CREDIT APPLICATION REQUIREMENTS:
   • All new customers must complete credit application
   • Financial statements required for orders > $25,000
   • Bank references (2) and trade references (2) for orders > $50,000
   • Corporate resolution authorizing signatory for credit terms

2. PAYMENT TERMS BY CUSTOMER TYPE:
   • Large enterprise (Grade A/B): Net 45
   • Mid-market (Grade B/C): Net 30
   • Small business (Grade C/D): Net 15
   • New/risky (Grade D/E): COD or prepayment
   • Government: Per statutory terms (typically Net 30)

3. CREDIT LIMIT REVIEW SCHEDULE:
   • All accounts: Annual review
   • Accounts with limit > $100K: Semi-annual review
   • Accounts with late payment: Immediate review
   • Accounts in declining industries: Quarterly review

4. CREDIT HOLD PROCEDURES:
   • Auto-hold at 110% of credit limit
   • Auto-hold at 31 days past due
   • Manual hold by credit manager at any time
   • Release requires credit manager approval + payment catch-up plan

5. DISPUTE RESOLUTION:
   • Customer disputes must be filed within 15 days of invoice
   • Finance resolves disputes within 5 business days
   • Good-faith disputes: Credit hold waived, continue shipping
   • Repeated abusive disputes: Require prepayment

6. BAD DEBT WRITE-OFF:
   • Accounts > 180 days past due and uncollectible: Recommend write-off
   • Write-off approval: Credit Director (≤$50K), CFO (>$50K)
   • Written-off accounts remain active for collection efforts
   • Tax treatment: Bad debt deduction claimed per tax authority rules

Edge Cases

Government customers: Generally low credit risk but slow payment cycles (Net 60-90 common); use credit insurance to cover payment delays; don't apply standard scoring
Startups and high-growth companies: Financial statements may not reflect true creditworthiness; evaluate investor backing, burn rate, runway, and customer quality instead
Related-party transactions: Affiliate or subsidiary customers; assess consolidated group strength but ensure arm's length terms for transfer pricing
Cross-border customers: Add country risk premium; consider currency risk; use letters of credit for high-risk jurisdictions; check export credit agency (ECA) coverage
Key accounts: Largest customers may pose concentration risk; maintain strong relationships even if credit profile weakens; consider credit insurance
Seasonal customers: Adjust credit limits seasonally — higher limits during peak season, reduced limits during off-season
Customers in restructuring: Monitor court filings, creditor meetings, and restructuring plans; assess recovery rate in bankruptcy scenario

Output

Credit Risk Dashboard

CREDIT RISK DASHBOARD — January 2025
======================================

PORTFOLIO OVERVIEW:
  Total credit exposure:    $12.5M
  Number of active accounts: 342
  Average credit limit:     $36,550
  Average utilization:      68%

RISK GRADE DISTRIBUTION:
  Grade A (Low):      180 accounts — $6.8M (54%) — Avg score: 91
  Grade B (Moderate): 105 accounts — $3.4M (27%) — Avg score: 76
  Grade C (Elevated):  42 accounts — $1.4M (11%) — Avg score: 62
  Grade D (High):       9 accounts —  $0.6M (5%)  — Avg score: 45
  Grade E (Critical):   6 accounts —  $0.3M (3%)  — Avg score: 28

TOP 10 CREDIT CONCENTRATIONS:
  Rank  Customer          Exposure    Grade    Days Past Due    Utilization
  ─────────────────────────────────────────────────────────────────────────
  1     MegaCorp Inc      $1,200,000  A        0                72%
  2     GlobalTech Ltd    $850,000    B        5                89% ⚠
  3     StartupXYZ        $620,000    C        0                95% 🚨
  4     RetailCo          $480,000    B        12               61% ⚠
  5     ManuParts Inc     $420,000    A        0                54%

EARLY WARNING ALERTS:
  🚨 StartupXYZ — 95% credit utilization + declining orders → Credit review triggered
  ⚠ GlobalTech Ltd — 89% utilization + first late payment → Increased monitoring
  ⚠ RetailCo — Payment 12 days late (first occurrence) → Check-in call scheduled

EXPECTED CREDIT LOSS:
  Total ECL provision: $58,000 (0.46% of exposure)
  Prior month ECL: $52,000
  Change: +$6,000 (+11.5%) — driven by StartupXYZ downgrade and economic adjustment

CREDIT INSURANCE:
  Coverage: 90% of insured accounts ($10.2M covered)
  Annual premium: $28,000 (0.27% of insured exposure)
  Uninsured exposure: $2.3M (mostly Grade A accounts)

Integration Points

Credit bureau APIs (Dun & Bradstreet, Experian Business, Equifax): Credit scores, payment history
ERP/Accounting (NetSuite, SAP, Oracle): AR aging, customer master data, credit limit enforcement
CRM (Salesforce): Customer financial data, relationship history, sales pipeline
Credit insurance platforms (Euler Hermes, Atradius, Coface): Policy management, coverage verification
Collection agencies: Account handoff, recovery tracking
BI tools (Tableau, Power BI): Credit risk dashboards, concentration analysis
ECL calculation engines: IFRS 9 / CECL modeling tools
Legal databases (PACER, court filing systems): Bankruptcy and litigation monitoring