In today’s dynamic business environment in the UK, the ability to identify, assess and mitigate credit risk has become a vital determinant of long-term viability, profitability and competitive advantage. With economic uncertainty fuelled by global challenges, UK businesses are increasingly exposed to counterparty risk, supply chain disruptions and the broader consequences of bad debts.
The realities of credit risk
Credit risk permeates nearly every commercial transaction, affecting cash flow, profitability and operational agility. Granting trade credit is a widespread business practice in the UK. According to the trade insurer, Atradius. 49% of all B2B sales in the UK are governed by some form of trade credit. Such arrangements fuel business growth and foster customer loyalty, but they also expose companies to potential losses that can quickly escalate without proactive management. 51% of B2B invoices are currently overdue and bad debts account for a further 7%. The strain on the financial health of companies is obvious.
The situation for smaller businesses is particularly challenging and is deteriorating. Research by accounting software specialists, Xero revealed the cost of late payments to UK small businesses rose to an estimated £1.6bn in 2023. This figure is more than double the 2021 estimate and reflects the cost of not having access to unpaid invoice funds.
Consequences of poor credit risk management
Ineffective credit risk management can extend far beyond the immediate financial loss from bad debt write offs; they can cause a cascade of negative outcomes:
- Cash flow disruption: Non-payment or late payment impairs a company’s cash flow, undermining its ability to meet its own obligations and invest in growth.
- Higher borrowing costs: Working capital strains may force businesses to seek external financing, often at unfavourable rates, eroding bottom line margins.
- Reputational damage: Persistent credit issues can damage relationships with suppliers, credit insurers, lenders and customers, downgrading market perception of financial stability.
- Operational disturbance: unpredictable revenue streams can destabilise inventory management, production schedules and workforce planning.
- Legal and administrative burdens: Chasing delinquent accounts often entails costly and protracted legal action, diverting resources from core activities.
- Management distraction: Diverting scarce human resources and management bandwidth to dealing with credit issues will inevitably harm overall performance.
- Insolvency: Poor credit management is widely acknowledged as a major cause of business failures.
Principles of effective credit risk management
Effective credit risk management is grounded in a holistic, proactive approach that balances commercial opportunity with prudent risk assessment. The core principles are:
- Know Your Customer (KYC) and Know Your Business (KYB): Diligent screening of an individual or company’s financial health, reputation and payment history is fundamental to informed credit decision-making.
- Clear credit policies: Establishing and communicating transparent credit terms, limits and procedures ensures consistency, avoids ambiguity and facilitates constructive discussions when problems arise.
- Continuous monitoring: Credit risk is dynamic; ongoing surveillance of customers’ circumstances, industry trends and macroeconomic indicators is essential.
- Diversification of risk: Over-reliance on a single or a small number of customers is dangerous; spreading risk across a broader client base reduces vulnerability.
- Early warning systems: Tools and processes to detect and to trigger action on the first signs of potential default, such as overdue and round sum payments or changes in order patterns are essential.
Strategies for efficient credit risk management
Leveraging data and analytics
Today’s credit risk management is data-driven. By harnessing internal data (sales records, payment histories) and external sources (credit bureaus, commercial agencies), businesses can build robust customer profiles and predictive models. Advanced analytics enable the identification of patterns and anomalies, facilitating timely interventions. Credit analysis systems, which assign risk ratings to customers, provide a structured basis for credit decisions.
Automating credit management processes
Automation is a key enabler of efficiency. By digitising credit applications, approvals and monitoring, businesses reduce manual intervention, minimise errors and accelerate decision-making. Cloud-based credit management platforms can centralise customer data, automate workflow and generate alerts for higher risk overdue accounts. Automation also supports scalability, allowing SMEs and larger firms alike to manage growing risk portfolios without proportionate increases in overhead costs.
Integrating finance and sales functions for credit management
Credit risk management should not operate in isolation. Seamless integration with finance and sales departments ensures alignment of objectives and fosters a culture of accountability. Sales teams should be trained to identify risk signals and support compliance with credit terms, while finance teams can use insights from credit analysis to optimise cash collection.
Proactive customer communication and relationship management
Building strong relationships with customers can mitigate credit risk. Open dialogue enables early resolution of payment issues and allows businesses to negotiate revised terms if customers experience financial hardship. A collaborative, solution-oriented approach often yields more favourable outcomes than adversarial tactics.
Using credit insurance and receivables financing
Credit insurance can provide additional protection from bad debts. While this involves additional cost, it can be a prudent investment, especially for businesses with significant exposure to high-risk sectors or international trade.
Receivables funding such as invoice discounting can improve liquidity, enhance risk management discipline and, dependent on the terms, transfer credit risk, though businesses should weigh the cost implications and potential impact on customer relationships.
Legal recourse and collection strategies
Efficient credit risk management requires a structured approach to collections, escalating from routine reminders to formal demand letters and, if necessary, legal proceedings. Utilising the UK’s County Court Judgments (CCJ) system can incentivise payment, but the process should be managed meticulously to preserve goodwill and reputation.
The future: A constantly changing landscape
The UK business landscape is evolving, with technology and geopolitical issues constantly creating market volatility. This inevitably changes credit risk dynamics, both in terms of UK and international exposures. Businesses must remain agile, continually refining their approach to credit risk management. Embracing digital tools, fostering cross-functional collaboration and investing in analytics are essential to staying ahead.
At Opus, we have extensive experience assisting business owners and directors with concerns and challenges, and we will always work with you to find the best solution for you and your business. If you would like to speak to Opus, one of our Partners would be more than happy to have a non-obligatory, confidential chat with you. We can be contacted at rescue@opusllp.com or call us on 0203 995 6380 and we will arrange for a call with one of our specialists.