An evaluation of the risk management process in the granting of credit by local SMEs

Abstract

The risk of late and non payment from customers is a recognised problem in local entities which can result in high liquidity problems if not managed properly. Small entities tend to be more vulnerable to the risk of late payments, due to their small size and the need to thrive in a highly competitive market. However, entities seem to recognise a credit problem at a late stage when the debts due have highly accumulated. Purpose: The purpose of this research is to identify the credit management procedures adopted by local SMEs prior to granting credit to their customers, and evaluate their effectiveness in reducing late payments and bad debts. This research emphasizes the importance for entities to be pro-active and have a structured risk management process in order to reduce their credit risk. Design: The quantitative research was conducted through a questionnaire sent to 300 small local entities, out of which 104 responses were received yielding a response rate of 35%. Findings: From the study it was found that local SMEs do carry out credit assessment procedures, however risk assessment is given the least importance in the credit management process. The most commonly used assessment methods are the credit application form and credit reference agencies. By performing assessment procedures, the entities have indeed reduced the late payment period. iii Conclusions: Through this research it can be concluded that the credit function is not given its required importance, and small entities may not feel the need to have a structured credit policy in place. A reason for this may be due to the lack of human resources that would be dedicated to the function. Value: Organisations need to be aware of the risks in providing trade credit, and that there are ways how to mitigate t competitive advantage in the market.