3.11. Commercial counterparty risk analysis

In assessing the commercial counterparty risk of a customer or supplier it must be taken into account that some countries have a culture of not feeling obliged to fulfill closed contracts or of not being very precise in sticking to agreed qualities or volumes or time limits, delivery dates and payment conditions. Such attitudes affect contracts with foreign as well as local public or private counterparts. Not foreseen by the foreign party it may have serious consequences. For cross-border transaction regime and rules for payment and repatriating dividends, capital transfer, debt service. There are a number of ways to find out whether counterparties are likely to pay their debts or deliver the goods in contract date. The most popular method estimate the finance condition of counterparty is the creditworthiness analysis.

During the cross-border dialing the company has to predict possibility of existence bad debts or delay of shipment. The procedure the estimation of creditworthiness consist the three stages. The first is the collection information from all possible sources. The second is the analyses of creditworthiness. The third is to make decision. The simplest way to assess counterparty’s credit standing is to seek the views of specialist in credit assessment. For example, there are rating agencies such as Moody’s and Standard and Poor’s provide useful information about risks. The rating agencies are usually available only for relatively large firms. However, we can obtain information on many smaller companies from a credit agency. Dun and Bradstreet is by far the largest of these agencies and its database contains credit information on 64 million businesses worldwide. Credit bureaus are another source of data on counterparty credit standing. Every credit bureau has the credit scoring model. Credit bureau scores are often called “FICO scores” because most credit bureaus use a credit scoring model developed by Fair Isaac and Company. FICO scores provided by three major credit bureaus – Equifax, Experian, and TransUnion. Finally, firms can also ask their bank to undertake a credit check. It will contact the counterparty’s bank and ask for information on the counterparty’s average balance, access to bank credit, and general reputation.

If managers have situation when they can not receive information about counterparty, then possible to use financial statement of counterparty and calculate some key coefficients which are provide as estimate the creditworthiness of counterparty. There are some key ratios.

Liquidity Ratios:

Current ratio = (2.11)

Quick ratio = (2.12)

Net-working-capital-to-total assets = (2.13)

Activity Ratios:

Average Collection period (days) = (2.14)

Inventory turnover = (2.15)

Receivables turnover = (2.16)

Sale-to-net-working-capital = (2.17)

Leverage Ratios:

Debt-equity ratio = (2.18)

Coverage of interest expenses = (2.19)

Profitability ratios:

Net profit margin = (2.20)

Gross profit margin = (2.21)

Return on assets (ROA) = (2.22)

Return on equity (ROE) = (2.23)¹³

The next step is to combine ratios as measures into a single yardstick. Edward Altman has used discriminate analysis to come up with the Index of Creditworthiness(IC). Multiple discriminate analysis (MDA) is a straightforward statistical technique for calculating how much to put on each variable.