What Is Credit Risk?

Credit risk is a concept that’s well understood in the world of banking and finance, where large institutions routinely assess the creditworthiness of their clients and counterparties. But credit risk doesn’t just apply to loans and bonds; it’s relevant in any situation where one-party supplies products or services to another and receives payment later. Businesses extend credit to customers to encourage sales. “Therefore, there is an inherent risk that customers could fail to meet their obligation to repay in full and on time. Put simply, credit risk refers to how we assess, control and reduce the likelihood of non-payment events,” states Gideon Bochedi, the COO of Credit Guarantee Insurance Corporation of Africa Limited (CGIC).

While large corporates have the infrastructure and governance in place to mitigate credit risk, as well as the cash flow to fund late payments or bad debt, SMEs operate on tight margins and are seldom equipped to handle a non-payment event.

Why Credit Risk Matters for Small Businesses

Here’s why credit risk is especially important for SMEs:

• Cash flow management: SMEs rely heavily on a steady cash flow to meet their day-to-day expenses. If a major customer delays payment or defaults, it can create a cash flow crunch that disrupts operations, delays supplier payments, or even leads to insolvency.
• Access to credit: SMEs often need to borrow money to finance growth, purchase inventory, or manage seasonal fluctuations. If a business’s credit risk is perceived to be high, lenders may either refuse to extend credit or offer loans at higher interest rates, making it more expensive to borrow money.
• Supplier relationships: Just as SMEs need reliable customers, they also depend on suppliers. If an SME business develops a reputation for late payments or defaults, it may find it difficult to secure favourable terms from suppliers, which can further squeeze margins.

CGIC operates within the credit data default space – protecting businesses against non-payment from their customers. “Typically, our product is geared towards companies with a turnover of R30 million and above, providing them with support in debt collection and safeguarding their cash flow. However, CGIC is currently working on refining its offering to provide even greater assistance to SMEs during their working capital cycles through negotiating better payment terms with their creditors through payment guarantees,” says Bochedi.

Bochedi believes that many businesses will hit a ‘rough patch’ at some point. “While there is a lot of support available during the inception of a business, there are not many people or institutions available that can help businesses navigate this ‘rough patch’. There is help available when a business is growing but struggling businesses do not know where to turn. Credit risk insurance companies like CGIC have that skill and knowledge and can help businesses navigate difficult times.”