Credit scoring is a method of evaluating credit worthiness of your customers by using a formula or set of rules. Most companies do not get this sophisticated though, they just purchase a credit report from a firm like Experian or Dun and Bradstreet and use that information to make credit decisions. Why? Because credit scoring is complicated and many companies do not have enough data to utilize credit scoring successfully. Not to worry; in most cases your own customer information, a credit report and trade references will be enough for you to make good decisions. Even so, it’s still important to have a general knowledge of credit scoring and business credit scoring best practices so you can decide if you’d like to use it in your credit risk mangement strategy.
TWO MAIN CREDIT SCORING METHODS
TRADITIONAL STANDARDS OF CREDIT ANALYSIS
Factors such as payment history, bank and trade references, credit agency ratings, and financial statement ratios are scored and weighted to produce an overall credit score.
This method relies on statistics rather than the experience and judgment of a credit executive. Key factors and data are generally captured from credit agency reports and the credit files of the client.
BUSINESS CREDIT SCORING BEST PRACTICES
- Match your scoring with your corporate objectives, customer base, and processes. For example, if your goal is to reduce DSO, you need to reduce the number of customers who are chronically late to pay their invoices. Do you have enough information for statistical samplings from customers? Do you have enough “bad events” (such as delinquency) to generate a behavioral pattern?
- Focus on creating greater efficiency. You don’t want to create more work; you want to reduce it as much as possible. Credit scores can help you drive efficiency in your credit approval and monitoring procedures, so you can make more decisions in less time regarding customer credit and speed up workflow; just be sure the scoring process doesn’t slow you down.
- Use data from as many sources as possible to increase accuracy. With more data points, you can come up with more accurate results. Look at your internal data as well as information from commercial credit bureaus to increase predictability and accuracy.
- Keep your accounts receivable information up to date and organized. If your accounts receivable data is not clean, coming up with the information you need for accurate credit scoring will be nearly impossible.
- Use technology to help you do it better! Accounts receivable management software like Lockstep Collect allows you to quickly see important external credit score and credit information with the ability to pull in information from up to three different credit bureaus. With a direct integration to top credit reporting agencies, like CreditSafe, you can be instantly alerted when something seems to be going awry with customers, using color coding based on credit risk associated with the account.