Guide: How companies can minimize counterparty default risk
The counterparty default risk describes the possibility that customers fail to pay on time or do not pay at all. Recognizing this risk of default at an early stage, keeping it constantly in view and taking measures to reduce it are essential tasks in credit management. The following tips will help you to minimize the counterparty default risk for your company.
1. It all starts with a creditworthiness report
Before you sign a contract and make your goods or services available to a customer it is important to find out reliably about the creditworthiness of this business partner. There are numerous suppliers offering diverse products to enable you to get this information. You should make your selection according to the type and volume of the business and the country in which it will take place. The information obtained forms the basis for setting the terms of payment such as the payment period and early-payment discount etc.
2. Set up monitoring
Keeping the creditworthiness of existing customers permanently in view is at least as important as checking the risk of default for new customers. Even long-standing, good customers are not immune from financial difficulties. For reliable monitoring it is a good idea to set up an early-warning system that informs you automatically when there are significant changes in creditworthiness. Your own payment records relating to the customer can, and should, also be included in such monitoring.
3. Prompt and correct invoicing
It goes without saying but is by no means trivial: great care must be taken with invoicing. In addition to writing invoices promptly, it is also essential that details such as the invoice address are correct and complete. The precondition for this is well-functioning master data management that enables automatic comparison of data with, for example, external information suppliers or databases.
When a customer fails to pay on time, your dunning procedures need to be activated. You should always, however, treat your customers individually and with tact – the primary target at first is to maintain and build on the business relationship.
4. Receivables management
If you want to be completely certain that you will not be stuck with unpaid receivables, there is the possibility to take out commercial credit insurance. The insurance pays for defaults which occur – minus the fees.
5. Securing risks
A further possibility to protect against default on receivables is factoring. By selling your receivables to a financial service provider you pass on the risk and thereby secure immediate liquidity.