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When Ahmed opened his design business in Dubai last year, he was delighted to land an ambitious client straight away. He took on a couple of staff and the team began working on a raft of assets for his first customer. Ahmed knew his business was "top heavy" – meaning he was reliant on this company to keep going – but he did not over worry. Then things went wrong.

As the global economy hit a rough patch, suddenly the substantial retainer payment stopped arriving, and e-mails and frantic phone calls went unanswered. A short time later, he found out the company had gone bust. Ahmed’s promising fledgling business crashed and he had to lay off his staff.

Stories like this are all too common in the UAE, especially with the current global upheaval.

Companies and consumers alike who are hit by hard economic times will either try to stretch out their payments or unfortunately fail to pay at all – something that can be disastrous for business.

For UAE firms, the key to avoiding this nightmare scenario is properly assessing the credit risk of customers.

If you’re a company considering extending a line of credit to a customer, ‘creditworthiness’ is one of the most basic concepts in business credit. Here are the five key steps – five crucial Cs – to determine the creditworthiness of a potential client or customer.

Capacity

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The first thing to look at is what is the business’s financial capacity to pay its invoices

Lenders need to be sure that the borrower can repay any credit based on the proposed amount and terms. The first thing to look at is what is the business’s financial capacity to pay its invoices? Does it have enough cash flow? Is it saddled with a lot of debt?

“Business credit applications typically ask the applicant to supply bank references, trade references, and financial statements,” said Leroy Pinto, Head of Marketing & Products, CRIF Gulf (Dun & Bradstreet). “These documents will reveal the applicant’s capacity to pay. If an applicant can’t provide financials or references, credit managers will need to find other ways to assess the capacity. Many consult business credit reports, which contain scores and ratings that can reveal a potential credit risk.”

Capital

Capital refers to the financial and non-financial assets that a business holds – plus the amount of money the business owners have invested in their company. If the financial assets listed in the financial statement demonstrate growth that may imply a lower risk of non-payment. Of course, having a financial statement makes it easier for a credit manager to assess the credit-seeker’s capital strength.

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Leroy Pinto, Head of Marketing & Products, CRIF Gulf (Dun & Bradstreet) Image Credit: Supplied

“It’s worth noting that some industries are more capital-intensive than others and this is where the non-financial assets – including real estate, inventory, machinery, and other equipment – can be helpful in determining creditworthiness,” explains Pinto.

Character

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The old adage that ‘past behaviour is the best predictor of future behaviour’ is one that lenders subscribe to.

The old adage that ‘past behaviour is the best predictor of future behaviour’ is one that lenders subscribe to. Trade references, payment records and a clean legal history in the business credit report help illustrate character. Before credit decisions were automated, the credit profession placed a strong emphasis on an applicant’s character and the professional relationship between the customer and the credit manager.

Collateral

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Inventory, machinery, and other equipment noted under capital as assets can be used as collateral.

Personal assets pledged by a borrower as security for a loan are known as collateral. Applicants with a less than perfect credit history may be asked to put up collateral to secure their debt obligation for a high line of credit – the same as any other type of loan. Here, the inventory, machinery, and other equipment noted under capital as assets can be used as collateral.

While collateral offsets the lender’s risk, it’s important to remember companies would rather work out a payment plan with their customers than try to seize an asset as part of the collections process.

Conditions

Conditions refer to the terms of the loan itself, as well as any economic conditions that might affect the borrower.

Pinto explains: “Let’s say two companies of the same industry and the same size each seek a line of credit, but one is located in a city with thriving demand and the other is located in a smaller market and has been losing customers to the competition for years. The thriving company seems low risk, but the other one may have growth potential if it has recently changed its business strategy to account for the competitive impact. Stepping back and considering macro-level conditions and opportunities for growth enables credit managers to make more calculated risk decisions.”

For a reliable partner in all your business decisions, get in touch CRIF Gulf (Dun & Bradstreet) at www.dnbuae.com