Credit scoring: focusing on business model viability
Executive Education / 22 June 2021
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Dr. Alexander Klein ist Diplom-Volkswirt und leitet eine hochspezialisierte Data Science Gruppe bei einer Großbank in Frankfurt. Er verfügt über 20 Jahre Erfahrung in den Bereichen Risikomanagement, Risikocontrolling und Portfoliomanagement. Darüber hinaus ist er als Dozent an der Frankfurt School und als Lehrbeauftragter an der Hochschule Coburg tätig.

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Crises – including, but not limited to, pandemics – often force us to realise that the tools and procedures we use to analyse and quantify risks only work properly in certain circumstances. If these circumstances no longer apply because we find ourselves in an abnormal situation, the key performance indicators (KPIs) we normally use to analyse a company’s creditworthiness may, in the best case, lose some of their potency as differentiators. But in the worst case, they may become both meaningless and worthless.

A closer look at long-term corporate viability

In such exceptional situations, it is especially important to analyse a business model’s long-term viability. First, because government intervention (whether negative, in the form of enforced closures, or positive, in the form of financial aid and liquidity injections) throws business figures into chaos, making it much more difficult to interpret and analyse them. And second, because such a crisis accelerates transformative social processes, inducing long-term changes in consumer, saving and investment behaviour over very short periods of time.

Even the business models of healthy companies can be impacted to such an extent that their survival over the short to medium term is placed in jeopardy. When analysing a company’s creditworthiness during such periods, the focus must shift away from the company and its immediate competition and instead prioritise a different question: will the customer needs currently satisfied by the company still exist in the near future, and/or will the company in its current form still be capable of satisfying them?

Analysing a company’s circumstances

Something known as a business environment analysis helps determine whether a company’s business model is still viable in changing circumstances. This analysis takes a systematic, in-depth look at changes in ambient social, technological, ecological, legal and economic circumstances, and then analyses their impact on the company’s business model, thereby helping to identify potentially significant risks threatening the company’s sales markets, supply chains and resource availability. Once these risks have been identified, they are reported to the senior management team so the latter can determine whether and to what extent the company is able to respond to these risks, open up new market segments and flexibly eliminate supply-chain bottlenecks.

Liquidity at risk?

It is important to remember that as well as the long-term viability – hence future profitability – of a company’s business model, the company’s liquidity may also be impacted by changing circumstances. If, for example, a pandemic causes production downtime because precursor or intermediate products or raw materials become unavailable due to lockdowns or obstacles to international trade, many companies will decide to stockpile more extensively in the future. In other sectors, the pandemic experience will cause suppliers to radically reduce or even cancel their payment terms. In turn, corporate liquidity requirements will change, often increasing significantly, and this too must be accounted for in any credit analyses.

Supplementing traditional credit analyses

Crises of historic proportions – such as the pandemic we have just been living through – and the accompanying uncertainties mean that we must supplement conventional credit analysis methods. Qualitative analyses and scenario-based techniques are becoming more important because correlations that were previously measurable historically are, as a result of structural breakdowns, no longer valid, or only valid to a limited extent. During such periods, analysts who have focused intensively on the long-term viability of a company’s business model have a big advantage when it comes to credit scoring. To make reliable predictions and safe investment decisions, expert knowledge of business valuation, liquidity analysis and risk assessment is vital. Frankfurt School covers all these areas in the Credit Officer certification course. And we also cover the skills required for in-depth credit analysis – especially for business customers – in our Credit Analyst (Business Customers) course.