Last week ("Our Take on Buffett's Annual Letter") we covered some of the highlights - from a credit manager's perspective - of Warren Buffett's recent annual letter to Berkshire Hathaway shareholders. This week, we're focusing on just one of his points that we think sums up the essence of what it takes to excel in our profession.

Buffett is a master at insurance, which is simply - like trade credit - the business of risk management. He wrote:

"At bottom, a sound insurance operation needs to adhere to four disciplines. It must:

1. 1. 1. understand all exposures that might cause a policy to incur losses;
      2. conservatively assess the likelihood of any exposure actually causing a loss and the probable cost if it does;
      3. set a premium that, on average, will deliver a profit after both prospective loss costs and operating expenses are covered; and
      4. be willing to walk away if the appropriate premium can't be obtained.

Substitute "price" or "credit limit" in place of "premium" above and you're spelling out exactly the role of a credit exec. Buffett continued, and here's where it gets interesting:

"Many insurers pass the first three tests and flunk the fourth. They simply can't turn their back on business that is being eagerly written by their competitors. That old line, 'The other guy is doing it, so we must as well,' spells trouble in any business, but in none more so than insurance."

We think this very simply, yet profoundly lays out what credit execs do, as well as perhaps the most difficult part of the job.

Not only must you be aware of the risks and confident in your position; you must also sell others on the wisdom of your position, which generally involves "walking away." Think of the very strong pressure to not "walk away" from any business. Human nature is no different for those managing trade credit as it is for those managing insurance risk.

Most (but not all) in our profession do well with the first three disciplines above, but like our fellow risk-managers in insurance, it's certainly a challenge implementing number 4.

There are all kinds of reasons for this, including, and especially, a lack of support from top management. But sometimes the responsibility lies in credit.

To truly excel in credit, you must be prepared to walk away when the credit isn't good enough. Easier said than done, of course. What that requires is a) good information, b) the skill to evaluate that information, and c) the ability to SELL others on your position and the wisdom of it. Two out of three won't do it.