The Importance of Scoring Model Review.
Do you review your credit scoring models on an annual basis?
Regular validation of scoring models is critical to ensure that the scoring results do not expose the company to unnecessary risk. With the volatility we’ve seen in today’s economy, heavy weighting towards long-term measures could over or under value the credit worthiness of a customer and their ability to meet short-term obligations. Monitoring the company’s ability to meet the short-term (12-18 month) obligations is vital to determine if a credit relationship should be offered.
Data selected for the revalidation should be reflective of the data used at the time of the model development. While some of the metrics you should review can vary by industry, you certainly want to consider the company’s ability to:
- Generate cash from core operations (% Change in CFO)
- Manage the Cash (CFO to Debt, CFO to Assets and Cash Conversion Cycle)
- Manage Debt in the Short Term (Interest Coverage Ratio)
This doesn’t preclude monitoring more long-term measures such as the growth of debt as it relates to underlying assets and/or debt, as in debt to assets or debt to equity. This can also be an indicator of the company’s ability to manage its assets in an effective manner so they are not borrowing or leveraging the company long-term to meet short-term obligations.
Regular validation of your scoring models is one of many best practices companies can use to remain competitive in today’s risk assessment marketplace. CreditPoint helps businesses be more efficient and eliminate frustration through credit software automation and service. To learn more about how your company can transform its business practices, click here.