Do your homework! The five “C’s” of Credit

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Small Business Group

Whether your business is just starting to export or is an established exporter looking to expand into a new market, the more due diligence you can do on your foreign partners and buyers, the less risk you take on. The extent to which you’re able to demonstrate how well you know your customer and the market in which they operate in, the safer your firm will be from foreign risks.

For a lot of people and firms, this would be obvious. Of course, you would research your foreign partners and buyers before entering into a

contractual obligation. However, based on our experience, there are many firms that don’t do enough research to minimize their own risks, let alone make an insurer or lender comfortable issuing a trade credit insurance policy or working capital loan guarantee.

The Five “C’s” of Credit

Although there is a never-ending list of considerations when researching a new customer, many firms use the five “C’s” as a basic framework for evaluating new customers. Look at these as a starting point for issues you and firm should consider:

1. Character

What actions can you take to determine the customer’s trustworthiness and willingness to pay obligations? The idea here is to identify a customer’s willingness to pay obligations. Anything that demonstrates morality, integrity and trustworthiness is useful. To do so, you can ask for documentation on past successful transactions, a documented payment record, as well as trade references, bank references, and credit history.  Identifying and contacting suppliers and buyers who can act as a reference can reval a lot about a potential customer’s character.  Character is considered by many to be the most important “C”.

2. Capacity to Pay  

What actions can you take to determine a business’ ability to operate successfully and pay when a debt is due? The goal here is to find evidence that a foreign partner has the ability to pay. This can be done by gaining access to financial documents that show a firm’s ability to generate cash flows or provides evidence of prior business experience, such as good operations and bill payment.

3. Capital

What actions can you take to determine a firm’s equity or net worth? Although not applicable to all transaction types and circumstances, gaining an understanding of a new partner’s net worth can go a long way in showing their ability to pay. This can be seen through financial statements that show a favorable trend of operations, increasing sales and profit, tangible net worth, and the amount the principals have invested.

4. Conditions

What actions can you take to determine how current and expected economic situations may affect a customer’s business? All businesses are affected by changes in national and international economy as well as industry cycles. When beginning to operate in a new environment, it is important to assess the country level conditions that could affect your customer or the transaction. This includes—at minimum—being familiar with the political and economic events occurring in the region, especially those that could pose a threat to your customer or transaction.

5. Collateral

What actions can you take to assess a customer’s access to additional resources? Understanding a customer’s access to additional collateral shows more than just their willingness to pay; it shows their ability to pull themselves out of a negative position before they are unable to pay. Therefore, an assessment of a firm’s assets can go a long way in determining the risk of getting paid.

Obviously, these five “C’s” are far from a comprehensive list, and should be seen as only a starting point.  There are resources out there to help you make the decision as to whether you can trust a foreign buyer. The Department of Commerce manages over 100 US Export Assistance Centers whose sole job is to help US businesses increase sales overseas. They have the resources and expertise to make sure you get what you need to be successful internationally. In particular they can provide international company profiles to analyze the financial health of potential partner.

EXIM Bank’s trade credit insurance can help you determine the riskiness of a foreign buyer.  And, your risk of non-payment can be mitigated by the export credit insurance offered by EXIM Bank.  The insurance is economically priced; and there is no fee to apply.   To find out how your firm can insure your risk of non-payment with EXIM Bank, contact Marianne Hughes, EXIM Bank West Region (Marianne.Hughes@exim.gov) Tel:  949-660-0603.

Marianne Hughes is a Regional Director with Ex-Im Bank’s Western Regional Office for the State of Arizona.  She has experience in international trade and marketing, trade finance, international credit procedures, and export credit insurance.