Last week we hosted a webinar, titled the “ The Importance of Scorecards for Credit Decisions ”. The attendee rate, participation, and feedback was overwhelmingly positive and we found that the topic holds value for anyone in the line of credit management and analysis. In case you missed the presentation, we’ve wrapped up a detailed summary for you in the blog post below.
Before we dive deeper into the topic it should be noted that whether we realize it or not, humans are scoring everything. Whether it’s a guilty pleasure TV show like Dancing With the Stars, posting a restaurant review on YELP!, or letting the number of stars a movie got sway your decision in purchasing a ticket; we’re scoring throughout nearly every aspect of our lives. We live in a pick and choose world where we can like or dislike something immediately, swipe left or swipe right to get to the next level, and everything in between. So how does this tie into business credit? Well the answer is simple; even if you’re not currently using an automated platform, the chances are that you’re already scoring your customers and prospects to some unofficial degree.
Why and When to Use a Credit Scorecard
There are a couple of fundamental reasons why we use scorecards for credit decisions. The most common of these reasons is to answer two simple questions: yes, no, or maybe? & how much? A scorecard system is best used to determine which of your prospects are qualified to receive trade credit. Once we have a yes, no, or maybe answer, we can move on to the next question. Picture your children asking for money to go out with their friends; first question: mom, can I have some money to go out with my friends? Answer: yes. Next question: how much?
We use scorecards primarily in two cases; extending credit to new customers and evaluating the limits of current customers. Your credit data provider is the primary source you go to for information on other businesses, which is why you trust them when extending trade credit to another business for the first time. Scorecards also assist in ongoing portfolio management. At least on a monthly basis, credit managers need to reevaluate their current customer portfolio and fill in any holes. Could some companies be spending more? Are we extending too much to a business showing signs of financial distress? Taking a proactive approach to these situations is key in ongoing risk mitigation.
The Challenges We Currently Face
It’s 2017 and credit managers have a lot on their plates. The challenges are incomplete data, excessive work volume, budget constraints, and the need for speed. There’s a lot to get done despite the missing information, and the budget isn’t there for additional employees to perform a manual credit review. On top of all this, sales guys and tacking on the pressure to close a deal and get their commission check. Everyone wants to move at lightning speed, but if our processes are manual, then speeding them up leaves more room for error. Using an automated scorecard system greatly decreases this risk.
Structuring the Scorecard
As with all credit practices, there are a standard set of data components that should be used in the creation of every scorecard. This list includes payment rating, predictive payment score, total balances, number of providers, age of business and any bankruptcies. Then there are the add-on components that you can use to build your “custom ride”. These include industry-specific insights, industry-specific payments, estimated revenue, estimated number of employees, late balances and more. Once you’ve picked the best combination of variables for you, you’ll have a very powerful scorecard that will make a credit decision for you. You’ll either get the green light to move forward or a red light asking you to take a closer look.
Structuring the scorecard is a crucial step in the process, but it may surprise you how simple it actually is. Essentially, the scorecard structure is an equation made up of multiple rules, variables and conditions. Each rule is multiplied by the weight you wish for it to hold. This gives you the total points toward approval. Our pro tip: structure the scorecard so that there are 10 points possible for each rule plus the total weighting adding up to 100. This will give you an outcome that ranges from 1-10. Simple, yet highly effective methodology here.
Using Multiple Scorecards to Improve Over Time
Applying scorecards to businesses is not necessarily a one-size-fits-all approach. If your customers vary significantly in risk profile, you might need multiple scorecards. The use of multiple scorecards is typically based on customer segmentation. Companies will behave differently depending on their size, product lines, and number of divisions. Different scorecards will be needed to address big ticket vs. little ticket issues. You can customize the variables and weightings so that each scorecard will have its own range of credit limits.
Using scorecards for credit decisions is a skill that can be improved over time. To do this there needs to be a champion challenger. You may find over time that you need to be more specific or make some changes in one particular area in order for your scorecard to perform at its best. In order to perfect the scorecard, you need to make one small change at a time on a regular basis via simple A/B testing.
In order to achieve success in new customer acquisition and ongoing portfolio management, even the most simple scorecard is worth implementing. When done right, a scorecard automation process will save you time and money while allowing you to significantly reduce risk, speed up your processes, and find a solution that fits within your budget. For more information on using scorecards for credit decisions, fill out the form here.