Companies are often caught in financial situations that can be difficult to identify by traditional means. Credit providers need the whole picture to make informed decisions to mitigate risk in their business.

This is why it is vital to place as much importance on how you arrive at credit decisions as much as why you're making them. Credit providers can fall for the trap of thinking of audited financial statements as the be-all and end-all of smart lending choices. However, the financial statement can often force businesses to rely too heavily on numbers without looking at the bigger picture. The rising cost of external audits can also leave a trail of unexamined financial records that can fail to accurately indicate if a company is in hot water.

Trade references, bank references and credit applications can all hold important clues to unravelling a company's financial situation, identify weaknesses early and safeguard against poor credit choices. But how do you decide what method is appropriate for which circumstance? The following will help you choose the best tool to make the smartest decision for your business.

When financial statements fail

An audited financial statement should always be the first port of call. However, an unaudited or missing financial statement will sharpen detective skills and force creditors to find other avenues for decision making. Creditors can gain a great deal from the amount of information on the company's financial situation from venturing into the sales arena. Speaking with sales representatives, customers and third parties will help navigate the company's credit history and decipher its financial situation through conversations with firsthand sources. It will also open up the channels of communication between sales and credit departments.

Credit Applications

Credit applications can serve as a great indicator of a company's financial health. Make sure all aspects of the document are thoroughly reviewed, ensuring that it allows for the recovery of third-party collection fees and court costs and contains a personal guarantee.

Trade References

Handy as trade references may seem, it is important to note that most customers will only share their best ones. Thinking broadly about the industry in question will help identify if major vendors who are likely to have supplied the applicant, have not been provided. Make sure missing references are researched to be better equipped to make a decision. It is also helpful to streamline reference checking procedures to get the best possible information from sources.

Bank References

Bank references can hold a great deal of information about an applicant's credit habits and general financial state. Get the name of an applicant's lending officer and ask them to notify the bank that creditors want to obtain information about the banking relationship.

Making better credit decisions will often hinge on a creditor's ability to successfully utilise different information sources. Knowing how, and when to use different methods will help minimise risk and significantly improve the decision making process.