The management of credit risk guarantees a business’s financial health and survival for the long run. Good management of credit risk can also take a business to the path of success and reduces any chances of threats arising from non-payment or late payment by the borrowers to the loan lender. Due to potential credit risk chances the lenders would closely analyze the customer’s creditworthiness, would set appropriate credit limits, and regularly monitor financial transactions.
Understanding Credit Risk
Credit risk simply refers to the potential loss that a lender gets in case of default in the repayment of a loan by the borrower. For MSMEs, some major factors that go on to affect credit risk include the size of the business, the type of the industry, financial health, and ability to repay.
Lenders, such as NBFCs and banks, primarily consider these factors to know whether the borrower is capable of repaying the msme loan amount or not.
Strategies for Effective Credit Risk Management
To increase creditworthiness and manage credit risk, the MSMEs should adopt the following strategies:
- Build a Strong Financial Foundation:
- Keeping proper and updated books of accounts for financial transactions with regard to income statements, balance sheets, and cash flow statements.
- Have a well-structured business plan that has financial projections for the business growth and strategies for the same.
- Maintain a proper financial management system that can trace income, expenditure, and cash flow.
- Gain a Good Credit History:
- Make sure to repay all of the debts like personal and unsecured business loan, credit cards, etc.
- Monitor credit reports regularly for errors.
- Limit the number of credit inquiries.
- Improve Cash Flow Management:
- Manage accounts receivable by making efficient collection processes.
- Manage inventory effectively to avoid excess costs.
- Negotiate favorable payment terms with suppliers.
- Do maintain funds for unexpected expenses in the business.
- Diversify Customer Base:
- Expand customer base to reduce depending on a few major clients.
- Implement credit checks for new customers.
- Have clear credit policies and terms.
- Risk Analysis:
- Identify the upcoming risks to the business, such as economic downturns, industry seasonal downtimes, and high competitive pressures.
- Do always have a plan to address potential risks.
- Consider purchasing business insurance to protect your business against unexpected losses.
Let’s see What are Best Practices in Credit Risk Management for Small Business Owners.
- Regular Financial Analysis: One should make a regular financial analysis to understand the financial health of the business and be able to know the chances of risks that might occur.
- Credit Scoring: Lenders will use credit scoring models and software to check the business owners’ creditworthiness and set the credit limits based on it. So having a good credit score is highly important, business owners can check their own credit score using different online tools.
- Employee Training: Train employees on credit risk management principles and procedures. Also, provide training on the work that they do in the business.
- Adopt Technology: Try to have a tool like credit risk management software to automate processes and improve efficiency.
- Build Strong Relationships with Lenders: Maintain open communication with lenders like NBFCs and banks and update them with regular updates on the business’s financial performance.
Conclusion
By working thoroughly on these strategies and with best practices, MSMEs will be better placed in terms of improving their creditworthiness, which supports you to gain a good chance of accessing loan facilities at reasonable terms. The management of credit risk improves access to finance but also plays an important role in business sustainability.
In particular, NBFCs are very supportive of the MSMEs on business loans and help during hard times in the business. If these strategies and practices are implemented in the MSMEs, they can easily ensure long-term sustainability and success, therefore being better positioned to get access to loan facilities under the most favorable terms possible. Credit risk management definitely not only improves the potential to handle risks but also gives the potential to get business loans from lenders.
