What is Default Risk?

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Businesses face a variety of risks in their normal day to day operations. The least of these risks is not default or credit risk which represents the risk of not receiving cash or other services for the products or services that you sell. While not all companies are exposed to default risk, those that extend credit to customers are and are faced with needing to manage these risks in a variety of different ways.

Types of Default Risk

There are many examples of default risk. Default risk can occur for banks and other lenders making loans to individuals or businesses. There is a risk that these loans will not be repaid which represents some form of default risk. Credit card lenders face the same default risks, which are addressed through charging higher interest rates on their loans. In addition, there is a risk that merchants who extend credit to customers or businesses will be unable to collect their advances and therefore experience default risk. The proliferation of credit cards and other forms of payment options for individuals to buy with a prolonged period of time has shifted the default risk for companies experiencing it away from directly to customers but rather to other businesses. As such, businesses who engage in business to business lending or credit are often the most significant firms that experience default risk.

How Do Companies Manage Default Risk Before the Sale?

Unlike some external risks, companies can manage their default risk and improve on collections by taking proactive steps and using default risk solutions to address the risk of default. The collection process should really start when a company is accepting a client with a detailed background check into their past history of paying outstanding bills and assessing both the risk of default and the amount of credit that they want to extend to the particular customer as a result. Once the firm has ensured that they have properly vetted new customers, they should install credit limits that are maintained for each customer, and follow these limits closely.

How Do Companies Manage Default Risk After the Sale?

Invoices should be properly prepared and a company should invest in their accounting staff to help to ensure that bills are sent out in a timely and accurate manner, which helps to improve on collections. Receivables should also be monitored and followed up on by an individual dedicated to the collection process after the sale is completed. Using aging reports and other tools to improve on collections and to monitor those accounts most likely to not pay is important a well. Firms should consider using an third party collection agency if they are experiencing problems with a customer not paying or even after ty default on a payment. If collections are slow and unpredictable, a company may want to consider using a factoring firm to help to provide a more regular cash flow to the business in order to help them manage their default risk and operations more effectively.

Default Risk Can Be Addressed

As noted above, while default risk is a real concern for businesses, it can be addressed and reduced proactively by businesses by taking certain steps.