Credit Risks: To take, avoid or insure?

Henrica Westhoeve
August 3, 2023 - Reading Time 5 minutes

Not only banks provide loans to companies; even when your business delivers a product and gets paid afterward, you are essentially granting temporary credit. The same applies when a company makes a purchase on installment. With the broadest sense of credit provision, risks arise. Can the company repay this credit? Will the company pay on time? Is it wise to take risks occasionally, or is it better to avoid them or insure against them?

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Insuring risks

Suppose you've just purchased a new car. According to the law, you must insure it, but the level of coverage you choose is up to you. Depending on the value of your car, you select an appropriate insurance plan, such as Casco or All-risk. Now that you're insured, it doesn't mean you'll suddenly start driving recklessly. On the contrary, you hope to use your insurance only in case of emergencies or high necessity.

Simply put, the same applies to your credit insurance. You can easily arrange this for your business, but you hope never to have to use it. However, the thought that you have it provides a reassuring feeling. Unfortunately, credit insurance costs are often high, and it may not always be sufficient. Credit insurers typically have strict requirements concerning how and why you extend credit. They wouldn't be insurers if they didn't rigorously scrutinize those requirements when you file a claim. So, insurance alone may not be enough.

Taking risks

But when is taking a credit risk justified? That depends on your so-called risk appetite. One company might be comfortable taking some risks, akin to driving a sports car on bumpy roads, while another company prefers to be cautious and not exceed the speed limit. Both companies don't want anything to happen, but they approach it differently. Whether you want to take a credit risk also depends on what you already know about a company. This is where business data becomes crucial.

Often, companies secretly rely on gut feelings, saying, "This customer has been paying on time for years!" What they often don't know is that the company barely survives each month, and bankruptcy may be looming. As a result, companies unconsciously take on more risk than they would like. This is where business data becomes crucial. What do you already know about the company? But, more importantly, what do other parties know about the company? External business data comes in handy here. Think of a Paydex (payment behavior of companies) or credit scores (how financially stable is a company, and what is the likelihood of bankruptcy). This way, you can take calculated risks and only assume risks that align with your risk appetite.

Avoiding risks

As humans, we naturally have a certain level of risk aversion, which is why we often prefer to have insurance. However, prevention is always better than insurance. It saves money and provides certainty. Having data about the customers you currently serve or intend to serve is helpful here as well. You may have been collecting data about your current customers for years, including payment behavior and locations. As previously mentioned, risks still exist even in this scenario.

The risk is even greater with new customers. With new customers, you often know very little. You can search and conduct research on Google, but here too, external business data can take you much further. Consider obtaining a quick credit report that provides you with information about a company. But platforms such as D&B Finance Analytics help you gain a good financial insight into all your (potential) customers and your portfolio as a whole. Monitoring can also be a good solution if you want to have a clear view of the credit risks associated with your (new) customers. If a customer's credit status changes, you receive an automatic notification. If we take it a step further, we're talking about Credit Risk Automation or an integration through an API in your own systems.

Interesting read: Credit risk automation in 3 steps

Besides being able to insure credit, you actually want to have control over how you manage your credit. This can be achieved by taking risks or avoiding them. In all cases, having access to external business data provides a significant advantage. If you want to know which solution best suits your company and situation, contact us below.


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