Interview with Mr. Bobby Rozario on Business Credit Risk Management (Part 1)

Recently, in coffee shops in Huaihai Middle Road, Shanghai, or wine bars in Taikoo Li, Chengdu, conversations between credit management elites are not like, "did BY's HR reach you? I heard that they are looking for Regional Credit Head," but like "RC is seriously in arrears, how long is their DSO for your company?" or "LKK's capital chain has been broken. Don't rely on sales staff alone!"

Are these changes "attributable" to the COVID-19 pandemic, trade disputes, or the ups and downs that often occur in regular business cycles? Anyway, 2020 was a challenging year for many industries. Many businesses failed to tide over this difficult time and had to file for bankruptcy and cancellation. The pandemic has accelerated the decline of businesses already in trouble or with tight cash flows. As a result, risks spread rapidly upstream and downstream among industries, with intrinsic crises further escalating.

If you seek advice from a risk control professional, he or she will probably advise you to keep an eye on your business partners. Every decision must be made carefully in today's increasingly capricious business climate. Understanding your business partners is especially important to guard against risks. But then, how to sniff out the truth from tremendous information? This process is so time-consuming and costly that many businesses cannot afford it.

The top concerns for decision makers are:

"How to find the truth from the tremendous information and even processed information?"

"Is risk assessment really that costly?"

"Are there any cost-effective credit investigation solutions?"

"Are there any methods or tools that can assist risk control?"

Today, we invite Mr. Bobby Rozario to share his opinions on the above questions. With over 30 years of experience in corporate risk management, Mr. Rozario is current Chairman of the Hong Kong Credit and Collection Management Association, a fellow member of Creditors International in the USA, Master Credit Executive of ACA International in the USA, founder of Alpha & Leader Risks and Assets Management Co. Ltd.

01 "'Data' are not equal to 'information'. Correctly interpreting information is more critical."

Xiaoan: Hello, Mr. Rozario. Thank you for taking time out of your busy schedule to chat with me. The fact that many businesses are on the verge of bankruptcy due to the epidemic has recently become a hot topic in the risk control circle. Even without the epidemic, business society is inherently risky. Many businesses have begun strengthening credit investigation and risk assessment on their business partners. As far as I know, free accesses to information mainly include news, the Internet, etc. What do you think businesses should note when collecting information in these ways?

Mr. Rozario: Hello, Xiaoan. I think it is good news that businesses pay more attention to credit risk management. Undoubtedly, the rapid development of the Internet has brought about many benefits. Convenient access to tremendous information on the Internet has facilitated business development to some extent. However, many people confuse "data" freely obtained on the Internet with "information". Actually, there are primitive and non-primitive data, while information is the correct interpretation of data, particularly primitive data. In other words, only data interpreted correctly are useful for credit investigation and risk assessment.

We can undeniably obtain massive amounts of information directly from the Internet. However, connections between information are complex. For example, events corresponding to information A, B, C, and D may be unrelated, interrelated, or occur successively. Plus, people with different backgrounds or experiences may interpret information differently. Therefore, interpreting information correctly is very important.

02 "Pay attention to the timeliness of paid information although it may be more specific."

Xiaoan: Indeed, there are tremendous data and information on the Internet. Some businesses search for information from specific information platforms to achieve more efficient information collection and risk assessment and then conduct risk assessment themselves. At the same time, some directly purchase credit reports or risk assessment products or detailed due diligence reports. What do you think should be noted in this respect?

Mr. Rozario: Alright. Businesses may obtain data and even information through the ways you just mentioned. However, free data and information are generally superficial, while paid information is more specific, although its timeliness should be considered. In fact, these methods have their advantages and disadvantages. Users may choose the one that is most suitable for them.

03 "Run Chart helps predict future results, thus improving the accuracy of credit risk assessment."

Xiaoan: You mentioned the timeliness of information just now. Timeliness is an important consideration when choosing which method to use. Which methods do you think are better in terms of timeliness?

Mr. Rozario: In general, all information we collect online is only valid at a specific point in time. For example, the total turnover of a business for a particular month of a specific year is X million. Therefore, judgments based solely on what happened at a certain point in time are inevitably biased. Credit risk assessment made based on Run Chart is more accurate and objective. I know some risk assessment reports recently emerging in the market have incorporated the Run Chart showing different data and ratios to present the development tendency of a business during a period. In this way, the need for timeliness of information is satisfied.

04 "An experienced credit control professional is well aware of the role and significance of these tools in corporate credit assessment."

Xiaoan: So, it seems that a credit assessment report is a tool that can help us interpret information. Do you agree?

Mr. Rozario: Sure. Credit assessment reports are generally divided into Feature Version and Detail Version. One is mainly presented via words and the other via charts. A wise credit control professional knows well the roles of these credit evaluation tools in different situations. A report presented mainly via charts shows the tendency of a business and thus responds to the concern of timeliness. Coupled with analysis, it can help better interpret information. Of course, it is undeniable that experienced credit control professionals are fully capable of directly interpreting the information and developing reasonable solutions without using tools such as credit evaluation reports. However, such experienced credit control professionals are rare. Wise credit practitioners are well aware of the advantages of each tool based on their experience.

05 "Generally, analyzing the trend of various data helps verify a business's 'health status' of and thus make more accurate judgement."

Xiaoan: So, interpreting information is really important because it helps verify a business's real situation and potential problems. Mr. Rozario, could you give us more examples of the Run Chart? How can we mine valuable information from the Run Chart for credit investigation and assessment purposes?

Mr. Rozario: Of course. For example, if a company's profits and revenues keep increasing, most people would intuitively judge that its business performance is good because its profit data are rising in proportion, perhaps even without an increase in marginal cost. However, the judgment made solely based on this information is biased. Recently, a Chinese listed retail company caught my attention. Although its profit and income seem normal, the increase in its asset-liability ratio is comparable to the growth of revenue and profit. After further studying these data, I found that the company has borrowed and invested a lot of funds in business expansion in the past year. Among its investments, it opened many stores in several cities. By offering discounts and distributing coupons, the company managed to realize a surge in revenue in a short time. This is equivalent to the practice of selling mooncake coupons by many large-scale cake shops. This practice receives cash flows in advance, so it is, in nature, a kind of borrowing. Cash inflows realized in this way will be recognized as liabilities under the accounting standards followed by foreign-funded enterprises. If a company frequently operates in this way, its asset-liability ratio will be unreasonable compared with its data in other periods or the data of peer companies. This is why it caught my attention. Here, I would like to introduce two significant risk control concepts: Trend Analysis and Industry Norms Analysis.

Generally, analyzing the trend of various data helps verify a business's "health status" and make a more accurate judgment. The rapid development of Internet technologies in recent years significantly facilitated data collection through this method. However, they are just data and valuable only after being turned into a Run Chart. Back to the first question. Can we come to the same conclusion if we collect information solely from the Internet? If the answer is uncertain, the risk control tools just mentioned can help us obtain information, analyze and evaluate the credit standing of subject companies, and achieve better effects.

06 “Do you know Pareto's Principle that 80% of the risks or troubles come from 20% of clients?

Xiaoan: Mr. Rozario, you said that risk control tools could save our time and energy in collecting and interpreting information for credit investigation and evaluation purposes. Credit assessment reports showing data trends can address the problem of timeliness of information. But what about the prices of these risk control tools? Are they costly?

Mr. Rozario: Different risk control tools have different roles and timeliness and can address different issues. Naturally, their prices are different. For example, a detailed due diligence report is recommended for corporate acquisition or merger or selecting an exclusive distributor in a province or city. Typically, indirect investigation (without notifying the subject of investigation) and direct investigation (with direct communication with the subject of investigation) are used in such scenarios. As finding a new business partner is not easy, implementing strict risk control procedures before establishing cooperative relationships is necessary. The cost of such a risk control tool (due diligence) is relatively high as it is time-consuming and requires a substantial input of resources.

Different risk control tools are charged differently. During the past 30-plus years as a credit management professional, I often receive such feedback, "We have purchased credit evaluation reports for years, and everything is normal. It seems that the reports do not make any difference." I would ask them back, "Do you expect every investigation to end up finding out that the subject is problematic or notorious? Or do you expect the subject is involved in many litigation records or administrative penalties?" If that is the case, you will be subject to high risks of delinquency as most of your clients have bad credit standing. Do you know Pareto's Principle (also known as the 80/20 rule)? In fact, many business activities conform to this principle. For example, if a company has 100 clients, roughly 80% of its risks come from 20 clients.

Let's keep things simple. First, collect Danger Signals (editor's note: in the field of credit management, Danger Signals can help judge the level of risk according to distinctive features, such as frequent delays in payments), and select 20% of clients for in-depth risk assessment. Second, conduct less complex investigations for the other 80%, and the input is negligible. There are platforms providing full-year records on being sued, changes in registration information, etc., and the cost is low, even lower than the expense of one meal. Besides, if only basic information is required, an ordinary investigation is enough and costs only a few hundred yuan. Third, if more detailed data are needed, the cost will be slightly higher than the former solution. However, discounts are generally offered if a certain threshold is reached.

07 “The necessity to conduct credit investigation, its type and choice of credit investigation agency are decided given businesses' respective situations, capacity, and industries, to establish a rational Safety Net.”

Xiaoan: You said that 20% of clients should be subject to in-depth risk assessment and the other 80% to simple monitoring. How should we balance the costs?

Mr. Rozario: Your questions are getting more and more incisive. Suppose a company has 100 clients in a year. According to the 80/20 rule, 20 clients should be subject to credit investigation. If the investigation cost per company is RMB 1,000, then the total investigation cost will be RMB 1,000 * 20 = RMB 20,000. If each of them contributes to annual revenue of RMB 100,000, then the total annual revenue will be RMB 10,000,000. So do you think it is worth spending RMB 20,000 on credit investigation to prevent possible credit issues? I would like to share my own experience to illustrate this better.

When I first came to China for business development 25 years ago, almost everyone around me didn't buy personal insurance because they thought it was useless. However, today, the situation is totally different. Most people I know over the age of 30 intend to buy personal insurance, especially those with children. Why? I don't think rich people need personal insurance. Just as I don't believe that personal insurance will provide any protection to Ka-shing Li, the richest man in Hong Kong. Poor people are not willing to buy personal insurance but would rather spend the extra money on their children's education. They tend to address their pressing needs without worrying about things in 20 years. Therefore, only the middle class or the well-off people really need personal insurance. Most of them live in first-tier cities in China. With more and more people becoming well-off in the Chinese mainland, it is imperative to build a Safety Net for the future.

Likewise, monopoly or leading enterprises may not need credit investigation tools as they have no competitors. They can confidently say, "No credit sales, cash on delivery only." However, start-ups or businesses with financial difficulty are in dire need of orders and won't miss any opportunity. Although sophisticated, they may not have an extra budget to purchase specific risk control products. Therefore, the necessity to conduct credit investigations, its type, and choice of credit investigation agency is decided given businesses' respective situations, capacity, and industries to establish a rational Safety Net. Of course, factors such as business experience, vision and awareness of the credit control personnel will affect this decision. Notably, after the outbreak of COVID-19, businesses are bound to pay more and more attention to risk control assessments.

That's all for the first part of this interview. Thank you, Mr. Rozario, for your time and sharing. Mr. Rozario has over 30 years of experience in credit management and risk control. His sharing is pretty professional, useful, and thought-provoking. In the second part of the interview, Mr. Rozario will explain how to apply credit investigation and risk assessment to day-to-day operations.