It should also place emphasis on cash reserves relative to debt obligations and working capital requirements, as well as the loss of a major customer or ongoing market competition. Additionally, automating credit reviews with credit scoring will help support SOX compliance with a highly reliable system to greatly minimize bad debt.Ī well-constructed scoring model allows you the flexibility to adjust ratios to improve the integrity of your results. In addition, automation frees up credit personnel time for other issues.

A strong credit scoring system is designed to catch these red flags, revoke credit limits, and greatly mitigate bankruptcies.Īutomating a credit scoring system will significantly enhance turnaround time for a credit decision. Solution: This is a dangerous situation where liquidity, cash flow, profitability, and leverage are all negatively impacted, leading to a potential bankruptcy. These facts often combine to cause pressure on a business to increase in borrowing and leverage. Hypothetical Situation Three: You have companies in your customer base you're concerned about because they sell mature products with little sales growth, eroding gross margins, weaker cash flow due to lower profit margins and declining customer bases. Solution, Utilizing Cash-Flow Analysis: The cash flow statement reveals the company is generating significant cash flow from operations, with no cash burn rate, strong cash reserves to meet interest payments on its debt, is funding future working capital requirements, and thus shows justification for a continued credit. Hypothetical Situation Two: Highly leveraged company prevents credit limit Solution, Utilizing Cash-Flow Analysis: The statement of cash flow reveals positive cash flow from operations and no cash burn rate operations are profitable outside the one-time charges, thus offering support for a credit limit. Hypothetical Situation One: The income statement shows a large net loss stemming from non-cash items such as write-downs of assets, restructuring charges, and early extinguishment of debt, leaving many reviews to curtail or eliminate the credit line. To demonstrate how adding cash-flow analysis to your credit scoring model can augment sales and reduce bad debt I've outlined three hypothetical situations, each of which is common for a credit analyst. A strong credit scoring system can have up to 50 financial ratios, including 20 cash-flow ratios, and it should be based on direct reviews of thousands of trade accounts where the system has historically produced very low bad-debt levels.Ĭredit scoring with financial statement analysis essentially sets credit limits for viable customers, sets prudent risk ratings, helps you increase sales and cash flow, decrease bad debts, allows for more frequent credit reviews, improves decision-making, and reduces operating costs.

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