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Understanding Your Risk Score

Understanding Your Risk Score

30 March 2022

In our Expert's Corner series, we share tips on how to get the most out of EQ Riskfactor. This month Richard Pride takes an indepth look at EQ Riskfactor's flagship measure, the Risk Score. Whilst many users consult this daily, many tell us they don't fully understand the data behind it. This article demonstrates why the Risk Score is so important and clearly explains how it is calculated.

Expert's Corner - What Is The Risk Score?

The Risk Score is designed to alert users to signs of potential distress for clients within their Portfolio. The higher the Risk Score is, the higher the perceived level of risk to the funder.

5 key areas influence the Risk Score:

  • Sales – invoices assigned by a client (increases only).
  • Cash – money received to pay assigned invoices (reductions only).
  • Dilutions – credits other than cash that are assigned to the ledger.
  • Cash Desperation – The apparent need the client has for cash.
  • Debtor concentration – the spread of invoices amongst different customers on a ledger (Factoring and clients where we receive extracted data only).

Debtor information is not always received into EQ Riskfactor, for example, in the case of Invoice Discounting clients. For this reason, every client's Risk Score is 'normalised', as described in Q1 below.

The Importance Of Reviewing Your Target DSO (Day Sales Outstanding)

Our clients regularly send us datasets for businesses that have unfortunately failed or been put into collect-out. We often see one measure that could have alerted users to an issue earlier, if it had been calculated correctly: the Target DSO.

The Risk Score is calculated in the background without any user input. However, for it to be accurate, the Target DSO must be regularly assessed and updated within EQ Riskfactor. Each business has its own ideal DSO, and if EQ Riskfactor were to adopt a one-size-fits-all approach to clients, the score would not be accurate.

Therefore, it is paramount that the Target DSO be regularly reviewed and set in line with the actual DSO.

Your Questions Answered

During our recent Masterclass, we covered 3 questions that all our users wanted to know more about:

toggle Q1 – What has the most weighting on the Risk Score?

A total of 7 or 8 different measures influence the Risk Score, depending on whether EQ Riskfactor receives debtor information for a particular business. These are given a score out of either 10 or 20, as shown in the table below:

  Measure Maximum Score
  Net Dilution  10
  Cash Desperation  20
  Current Account Recovery (30 day)  20
  DSO vs. Target DSO  20
  Cash Turn vs Target DSO  20
  Average Sales Daily Movement  20
  Average Daily Cash Movement  10
  Top Debtor Concentration *  20

*(Only available for clients where the largest debtor info is received, e.g. factoring, clients with extracted data)  

Total scores are either 120 or 140, depending on whether the Top Debtor Concentration measure is included. The Risk Score is 'normalised' and given a score out of 100 by the software, allowing users to compare factoring and invoice discounting clients.

In the bold text above, 40 points (up to a third of the total points for an invoice discounting client) are influenced by the Target DSO.

If a Target DSO is set too high, the Risk Score will not include any potential increase in its DSO until it hits the Target DSO within EQ Riskfactor, at which point the business may already be at a point of no return. On the other hand, if the Target DSO is set too low, the Risk Score will be artificially inflated, demanding more time from the user, which could be better spent on other clients.

We recommend that the target DSO be regularly reviewed as a minimum on an annual basis. EQ Riskfactor gives all new clients a target of 60 by default, so make sure your clients are correctly set up from the start.

To avoid changing the Target DSO in error, we recommend that Review Templates are used within EQ Riskfactor to provide an audit trail of why a Target DSO was changed. We also recommend that only certain users within an organisation have user permissions set to change Target DSO.

toggle Q2 – Is it sufficient to monitor portfolio risk solely by using the Risk Score as your daily/weekly metric?

The Risk Score is extremely useful and gives an overview of the perceived risk of a client. However, EQ Riskfactor offers many different measures and workflow processes that can help a user better understand a business's risk.

Focus Lists alert users when any clients breach a set of given criteria. For example, whereas the Risk Score does include swings of positive sales movement, it does not give points for a reduction in sales. A Focus List can be set up to flag a user when a client sees a prolonged drop in sales. The Risk Score would not highlight this change.

Portfolios are generated using a set of risk-based criteria. Users can set up reports to send key information regularly by subscription. Focus Lists, Portfolios and Subscriptions were not covered in our recent Masterclass, but please do reach out to your Account Director if you have any questions regarding setting them up or using them.

toggle Q3 – Which Risk Score measure should we use and why?

There are two Risk Scores available within EQ Riskfactor:

  • The standard Risk Score - the total of all the individual 7 or 8 scores.
  • The normalised Risk Score – the same total normalised to a score out of 100.

We would therefore recommend that the "Risk Score (Normalised)" be used for comparing clients and the "Risk Score" be used to identify what is driving the change in risk.

How Alarms are set within EQ Riskfactor might mean that a standard Risk Score turns to Caution or Alert, whereas the Risk Score (Normalised) is given a lower risk.

This article has revealed more about using the Risk Score in your daily risk monitoring and explained how this key metric is calculated.

If you have any additional questions, please reach out to your Account Director. If you are new to EQ Riskfactor please get in touch with us below.

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