Customer Credit Decisions: Easy Approvals vs. In-Depth Analysis

I wanted to drill into key factors that influence a credit decision, so I asked Bill James, Creditsafe’s Enterprise Sales Director, for his perspective. We started with high credit scores and credit limits.

Bill said, “Credit scores and credit limits are the two most common data points that businesses will look at when vetting potential customers. And often there’s a lack of insight into a company’s financials, especially if they’re privately held.”

To put this into the context of how a high credit score and credit limit could help a company get easily approved for credit, let’s look at these two data points in more detail.

• Credit score: When you look at a business credit report, you’ll see an international credit score, which is typically signified by a letter grade (A-E). A company that has its finances in good standing, has a good track record of paying invoices on time and has a low debt to revenue ratio is likely to have a higher credit score. So, if you see a company with an international credit score of A, that signals that it’s considered to be a very low risk and will increase its chances of getting approved for credit.

• Credit limit: Credit limit is often an indicator of how strong a company’s finances are and how much debt they’ve accumulated. Typically, if a company has a high credit limit (over $1 million), that’s a sign of good financial health. Of course, that figure will increase significantly based on a company’s size and annual turnover. So, you’d likely see publicly listed companies with a credit limit around $50 million.

Bill continued, “I always tell our customers to use credit limit as a guide and not the gospel for their decisions. It’s important that they get the full picture into a customer’s financial strengths and weaknesses. The sum of all parts is greater than these 2 data points alone. They should then use the full data picture to make informed decisions about how much credit to extend.

Now if you’re considering extending more credit than the recommended limit, you’ll want to look at their trade payment history. How are they paying their bills? Are they paying on time or is it typical for them to pay over 15 days past the payment terms? Do they owe a large amount of money? Has their DBT score dropped significantly in recent months? Look at all these metrics together and follow that trail.”

So, when is a high credit score and credit limit not enough to warrant a quick credit approval? This usually happens when there are inconsistencies in the financial history and behaviors of a company.

For example, evidence of legal filings like court judgements and lawsuits could indicate that a high amount of cash will be needed to go towards paying off debts. (A recent case of this was with Revlon, which had $3.5 billion in debt).

For example, a company’s credit limit could be reduced significantly if it’s embroiled in financial and legal troubles. What do I mean by ‘embroiled in legal troubles’? Let’s say a potential customer’s credit report shows that they have 25 derogatory legal filings, which cost the business $2 million. That’s definitely a clear sign that something could be amiss internally – or that income has declined and cash flow is weak. So, even if the company has a reasonably high credit score and credit limit, those data points shouldn’t be ignored. In this case, we’d say this scenario would likely fall into the ‘in-depth analysis’ category from the finance team.

While legal troubles won’t necessarily stop a credit decision from being approved, it can slow down the approval process. Finance will need to invest more time in investigating and following up on whether these cases have been resolved and the financial ramifications on the business. 

Company size and annual turnover go hand -in-hand in determining how quickly a credit decision gets approved. This is because smaller companies might not generate as much revenue as larger organizations. So, in the eyes of the finance team, smaller businesses will need to show greater evidence that they’re paying customers on time, have enough income and cash flow to sustain operations and are growing their revenue steadily.

We’ve found mid-market companies with annual revenue of $10 million to $1 billion seem to be the easiest to approve because, on average, they’ve shown more flexibility and openness to adapt to changing circumstances. There are always exceptions, of course, and we don’t want to generalize.

As Bill James explains, “Annual turnover is a deciding factor for seeing what lines of credit an organization is eligible for. But digging out these types of figures and analyzing the data can be quite time-consuming if you’re relying on a manual process. Making a credit decision with millions to billions of dollars involved could take anywhere from two to five days. If a customer gets frustrated by this process, they might decide it’s not worthwhile to work with your business – that’s lost revenue simply because your credit decision process was clunky and long. 

Debt is a major deciding factor for credit approval. If your business has little to no debt, that’s going to improve your chances of securing credit. On the other hand, if you have a high amount of debt, that’s a sign that you may be overspending, don’t have enough income to pay off the debt in a timely manner and are then falling into a continuous cycle of taking out loans or financing to keep the business running.

Just look at the situation with Party City. In March 2022, the decorations retailer reported steady sales growth. We can imagine the company was likely getting approved for credit quite easily at that point in time. But then in January 2023, Party City racked up $1.9 million in past due payments, forcing the company to file for bankruptcy.

This case study proves that financial stability is never a guarantee. It fluctuates often and is influenced by many factors, both internal and external. The key takeaway here is that you should constantly be monitoring fluctuations in debt and past due payments when vetting customers. If they have too much debt and aren’t taking care of their ongoing financial responsibilities, that indicates poor financial management, which will likely result in further problems down the line.

It’s also important to consider the type of debt, as Bill explained.  “There’s always good and bad debt. Savvy credit managers can tell the difference. Good debt is debt leveraged to grow the business and invest back into it. One way to do this is through accounts receivable. As long as the company has strong annual turnover and good debt collection strategy, that’s good debt.

Bad debt, however, would be if you see a business has maxed out multiple lines of credit. Put another way, it’s the variable types of credit that could potentially be abused by a company that is in a cash current situation.”

Carrying on from the previous point, the percentage of past due payments should never be overlooked in relation to how quickly a company pays. There’s a big difference between a company that occasionally makes late payments and a company that’s consistently making late payments. I’m talking about when a company pays the vast majority of its payments on time but then occasionally pays a few invoices late, in comparison to a company that pays over 50% of its invoices late and those late payments amount to millions of dollars.

But it’s not just this metric your finance team will focus on. You’ll also look at the reasons why payments are being made at certain times. Late payments aren’t always a bad thing. Let’s take Whole Foods, as an example. Overall, the grocery chain does a good job of paying its suppliers on time with just 8% of invoices paid late. Considering how big the company is and the large number of suppliers it works with, that’s a good sign that the company is managing its finances well and takes care of its responsibilities.

Whole Foods didn’t do this because they were struggling financially. We saw they had a healthy credit score of 80 and they asked suppliers to reduce prices because it enabled Whole Foods to maintain a healthy cash flow. Now, compare that to Revlon, which had 41% of supplier invoices paid late. Clearly, there were problems going on in the background with Revlon. These are problems that would certainly be revealed in a deeper credit review of the business before extending credit.

Bill encourages businesses to go beyond the data point of percentage of past due payments. “Don’t just look at the overall percentage because it’s dollar weighted. So, if you have one large bill that was late and is in dispute, that could really skew the percentages. I always tell people to take a deeper dive into the full details of the trade payment data. The higher the number, the worse it is. On a surface level, if it’s 20% or higher, then look at the payment history and see if it’s a large, single transaction that’s a big dollar amount. That could indicate that it’s an outlier. Analysis is always key.”

Another important comparison to make is between companies that have a low DBT score of 5 or under and those with higher DBT scores (over 10). The lower the score, the more reliable a business will be and more likely it will be to pay on time.

Again, you can never make blanket assumptions about anything. You should always check the DBT score and couple that with other factors like company size and payment terms. So, when analyzing a large organization and seeing that its DBT score is 19, you’d be right in having concerns about the company’s ability to pay on time.

It’s also important to not just look at the DBT score overall, but to look at how it compares to other businesses in the same industry. We call this DBT peer analysis. This helps benchmark the average DBT score within an industry and see how an organization is performing against its competitors.

For example, the average DBT score in the grocery chain industry is 7. But if your team is considering signing on with a customer that has a DBT score of 16, then this is likely to push them closer to a decline. Or at the very least, it could indicate that further analysis is needed before you can make an informed decision.

Bill had this to say about DBT scores. “A DBT score of 5 to 10 is a widely accepted range. In current economic conditions, companies may take on slightly more risk to either maintain market share and revenue numbers, or to go after more market share and revenue growth. We’re seeing more acceptance of higher DBT numbers. This is happening in a diverse set of industries, including wholesale, distribution and technology.”

The key takeaway here is that there is no one-size-fits-all solution. It’s very nuanced and often requires much deeper analysis before a proper decision can be made.

If you want to avoid losing a potential customer, automation will be your best friend. It gets a lot easier with automation. Using AI to improve your credit decision process will deliver multiple benefits, including reducing your capital costs, minimizing human errors and speeding up the decision process. There’s also the benefit of standardizing everything from a credit policy standpoint and making sure all data is consistent.”

We recently ran a mini study of 334 financial managers in the US to get a better picture of their credit decision process. The results we found showed just how labor-intensive the credit decision process is.

• 97% of businesses process up to 100 credit applications a day.

• Several people are involved in the credit decision process. For instance, 63% of businesses involve up to five people in the credit decision process. Meanwhile, 22% said credit decisions are typically made by six to 10 people and 14% said over 10 people are usually involved.

• It’s not a quick process either. We found that 75% of businesses take up to a full day (8 hours) to reach a credit decision on each new customer. Meanwhile, 16% said it takes between one and two days to reach a decision and 10% said it can take over three days.

Bill believes a happy medium between technology and a human perspective is the way forward. “There needs to be the right mix of human and AI collaboration. It’s about finding the right balance of automation in making credit decisions and onboarding customers.

Some companies expect a credit approval rate of 80 – 90%. To get something that high, they need to be willing to take more risk. They could say they want 60% of their applications to be approved, but that still leaves 40% that are either going to be declined or need more in-depth analysis. Typically, we see between 10 - 15% of applications get automatically declined, meaning you wouldn’t loan these companies any money, let alone a stick of gum. So, you could have analysts on your team who spend a good portion of their time running in-depth analyses of 40% of all credit applications daily.”

Bill had one final point to share on the future of AI in finance and it’s definitely worth sharing. 

“Recently, I was at a conference and sitting at a table with a bunch of CFOs from billion-dollar companies. I started talking to them about tools like ChatGPT and it amazed me how many of these individuals had no clue what ChatGPT is or how powerful tools like it are in finance. As AI continues to evolve, financial teams will have to feel their way through it. But they absolutely will benefit in the long run. I see more data providers and workflow providers incorporating it into their platforms.”