A 360° approach to risk grading: why numbers are not enough

Risk grading is a lot like projecting the future success of an athlete. You can’t just rely on past numbers. You would also need to consider changes to an athlete’s training regimen, if new teammates will play to an athlete’s strengths, how the competition is evolving, and the specifics of the upcoming season.

Similarly, credit analysts can’t rely solely on data and advanced algorithms to help assess credit risk. I should know: after 25 years in business risk management, I’ve seen how important it is to understand the specific context of each company. However, I meet a lot of people who still think that risk grading is based on just a handful of financial documents, which would be like thinking the athlete is doomed to fail because of one bad game.

A comprehensive approach

In trade credit insurance, you ultimately want to predict the likelihood that a company will pay a supplier. Risk underwriters use a credit grade to decide if they can offer trade credit insurance coverage on a particular company, but it’s not as simple as using the company’s own records to determine its financial health.

There are a number of factors to consider in order to determine a company’s financial health and its future risk exposure. These span macro and microeconomic factors, and include a 360° review of the company in terms of governance, strategy and what’s happening in its market and sector. Here are the key things to look out for when determining the creditworthiness of your customer:

Country and region

A thorough risk analysis includes the economic, political and business outlook in the company’s geographic area for both the short- and mid-term. For example, operating in a country with less stability represents a higher credit risk.

Administrative information

Consider the type of legal entity of a company. How many years has it been in business? How much share capital do shareholders have to lose? (The higher the number, the more shareholders will want to avoid bankruptcy.)

Stakeholders and leadership

Is the company family-run or public? This often impacts how committed owners are to investing further in order to keep the company afloat. The leadership’s record and vision should also be taken into account.

Sector

Look at evolutions within the company’s sector. This does not mean penalising an individual company just because the overall industry is not doing well. Instead, the evaluation should focus on how a company is doing compared to competitors.

Customers and suppliers

It’s not enough to stop at the company in question: analysing its clients’ financial health is another important factor for determining future financial solvency. You should also determine whether the main company is dependent on raw materials with fluctuating prices.

Production lines and operations

The state of a company’s machinery and the possibility of disaster striking its facilities are important risk factors. The analysis should also include the status of the company’s workforce, in terms of the amount of people on full-time versus casual contracts.

Past financial results and payment history

This covers the company’s financial results in the last fiscal year, including their turnover, gross profit and profit margin, as well as a review of its client base to see if a company has missed past payments.

Future financial outlook

Finally, have a look at the company’s financial and strategic outlook for the upcoming 12-18 months, maximum. What is their business strategy? What’s in their order book? And importantly, what is a company’s liquidity and short-term debt outlook?

Keeping your ear to the ground

As Executive Officer for Allianz Trade in Southeast France, I manage a team of 40 credit analysts with extensive knowledge of the local markets. When we determine a company’s risk grade, it’s not about considering standard data on a spreadsheet: our global presence and local teams enable us to leverage a wealth of data and give personalised advice.

To me, keeping close to our clients and understanding the whole picture is not just an added value, but essential to successful business risk management.

Got questions? Connect with Gilles

Gilles Paillard

Executive Officer of South West France,
Allianz Trade in France

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