You may also be interested in:


3 Elements of a Comprehensive Receivables Risk Assessment

  • By David Culotta
  • Published: 8/19/2019


With an unfolding trade war, the continuing Brexit saga and a potential downturn looming, uncertainty is the new normal. While conducting a comprehensive risk assessment of your receivables is always important, it is especially vital now, given the potential for rising payment default risk.

Simply put, receivables are the lifeblood of a company. If customers begin paying later and later or are suddenly unable to pay at all, your company’s ability to fund operations could be threatened. A comprehensive receivables risk assessment is incomplete without three key elements.

1. A regular review of your receivables aging report

This task usually falls to credit managers. A receivables aging report aggregates unpaid customer invoices and unprocessed credit memos into buckets based on the number of days specific invoices have fallen beyond terms. It’s a simple way of tracking overdue invoices and determining how well your credit and collection functions are working. Whether credit managers are looking over the aging report daily, weekly or monthly will depend upon the size of your company and its counterparties and the significance of the transactions at hand. Whatever the case, regular review is critical.

If your receivables aging report begins to reflect a material deterioration in trend, it may be time to investigate what’s causing late payments before your customer’s problems translate to a serious cash flow issue for your business. Maintaining regular contact with the buyer and tight credit controls will allow you to closely monitor such trends. In addition, it’s important to understand the difference between industry-standard payment practices and early warning signs that your customer is experiencing financial stress. Focusing on deviations from typical payment patterns is key.

2. A regular credit analysis of trading partners

While the aging report provides a snapshot in time of customer payment behaviors, it won’t necessarily reveal specifics as to the financial strength of your underlying counterparties. To gain this level of insight, you’ll need to conduct fundamental credit analysis of your trading partners at least annually. The frequency of the analysis should increase relative to the credit risk profile of the customer with higher risk credits and more vulnerable buyers put on quarterly or semi-annual review cycles.   

Include both bottom-up and top-down analyses. From a bottom-up perspective, key focus points include: Is the company generating cash? Is it profitable? Does it have sufficient liquidity to pay on time? Focus in on your customer’s financial statements and banking information, paying particularly close attention to how your customer is financing operations and working capital needs and the overall trend in total liquidity. Trade references and bank references can also provide meaningful insights into payment behavior and access to capital. Red flags and early warning signs include a heavy reliance on external financing, chronic poor payment practices, a deteriorating cash conversion cycle and an unexpected decline in total liquidity.

With regards to top-down analysis, take into consideration: What are the current macroeconomic trends impacting purchasing behavior within the industry? What are the current payment trends in the industry? What current external factors could materially impact the trajectory of the industry in the near future? What do analysts predict for the industry in the next six to 12 months? To answer these questions, you’ll need to stay on top of industry news and analyst insights.

3. Initiating processes to manage deteriorating payment trends

If your customer typically pays on time but suddenly is paying two weeks late, what do you do? If you don’t have detailed processes in place to manage deteriorating payment trends, customers are likely to take advantage of the “free” vendor financing. You should have systems established for quickly addressing and resolving late payments. Depending on the customer, your established history and the perceived level of payment default risk, you may want to put a credit hold in place once the aging report has reached a certain threshold or have your internal collections team facilitate a call with the customer. If those steps don’t solve the problem, have an escalation plan in place for written notices and legal action.

Your credit risk management approach should also include a defined process for evaluating requests for extended terms. The key is to separate out legitimate requests for extended terms related to seasonal working capital needs or one-off purchasing opportunities as opposed to an extension to avoid significant financial distress. Ask focused questions to get to the bottom of their request. If the customer is unable or unwilling to be forthcoming, that’s probably a red flag.

Building in additional contact points with customers is recommended. Identify your high-risk customers and create personal contacts through an in-person visit. Personal interaction could lead to an increased understanding of the corporate strategy and future outlook and ultimately could drive increased credit support. The development of personal relationships will frequently lead to a greater comfort level with a customer’s management team and their ability to effectively manage liabilities. This approach also gives you a chance to watch out for some of the softer signs of impending financial trouble, such as questionable management decisions, high turnover among senior management and problems with succession.

David Culotta, CFA is the Senior Manager of U.S. Buyer Underwriting for Atradius Trade Credit Insurance Inc. located in Hunt Valley, MD. In his role, David is responsible for providing strategic direction for the U.S. underwriting platform and for monitoring the development of the U.S. portfolio and adapting the risk management approach as necessary.   

For more insights, check out the Payments and Risk Management tracks at AFP 2019.

Become an SAP Financial Super Hero
Learn how to streamline everyday SAP FICO processes as you navigate the reality of a “virtual” financial close. Discover how to automate processes and improve productivity with Z Option GLSU – and eliminate the need for IT involvement. 
Close the books like a hero. Schedule a Demo.

Copyright © 2020 Association for Financial Professionals, Inc.
All rights reserved.