As a Credit Manager, your primary responsibility is to evaluate the credit risk of selling to new applicants and existing customers in your AR portfolio. The objective is to maximize profitable revenue opportunities with managed risk. To manage credit risk, you are likely to have risk mitigation measures in place, such as guarantees, UCC secured arrangements, and other forms of structured payments and liens.

You should also be prepared for an acceptable level of loss. We all know, that too high a level of write-offs is bad, but too little is maybe even worse. When no risks are taken, it can stifle business opportunities, where the profit gained over a period of time, can far exceed the potential loss. The key is to be clear-eyed and prepared by keeping a close watch on your company's exposure, particularly when dealing with high-risk customers.

A good place to start is by taking a close look at your customer's historical and current financial statements. In order to monitor and evaluate risk on an ongoing basis, consider the following three focus areas. Each will bring added transparency to financial reports:

   1. Accounting Analysis:

Focus on transactions that seem difficult to understand, or which deviate from normal accounting policies. These may hide manipulations of reported profits or losses. Look closely at critical elements such as the company's accounts receivable portfolio of customers to identify potential risks to cash flow or losses. Compare your own assessment with the adequacy of the customer's stated reserve for losses.

Check to see if the company consistently accounts for similar transactions, or are there differences? Look at how assets are tracked and valued. Is the basis, consistent? Does the company use a “First in First Out,” “Last In First Out,” “Average Price/Weighted Average Price,” or a Specific Identification method? Understand the accounting policies related to such things as depreciation, amortizations, and investments.

Take a close look at accounting estimates for such things as the life of equipment, the amortization of intangibles, doubtful accounts, termination and retirement liabilities, and tax obligations to name a few. Are they realistic?

   2. Common Sizing Analysis:

Try converting all items in the financial statement into a percentage of the total assets or total revenue. Also, track the percent of change of each line item from one reporting period to the next. You can also use this to easily evaluate trends. This form of tracking also provides a benchmarking tool to compare two similar companies in your own portfolio, or from other industry groups or public sources.

  3. Ratio Analysis:

Ratio analysis will help you look behind the numbers.  With year after year comparisons and benchmarking with similar companies, you can gain insight into a company's performance, profitability, efficiency, and financial structure.

You will be able to link financial performance to factors affecting the company's business. Look at debt, income, and liquidity ratios. Ratio analysis will help you focus on areas of concern for deeper due diligence.

Solvency Ratios provide insight into how a business is funded. Is there a high reliance on external debt as compared to shareholders' willingness, or ability, to provide sufficient funding to sustain and grow the business? Is the company adequately funded to support short, and long-term liabilities? Is the company over-financed compared to similar companies? Is there a risk that a lack of liquidity will lead to bankruptcy?

Performance Ratios give insight into revenue and the associated costs. Look at the business and performance ratios and trends illustrating such things as The level of sales growth or decline, sales to operating capital employed, the utilization of fixed assets, profitability, and leverage.

Ratio analysis will give you valuable insight into how a company is funded and managed. By looking at trends you can also gain insight into future performance.

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